China’s funds industry is becoming increasingly institutionalised, courtesy of the growing outsourcing demands of the country’s commercial banks. The latter firms are turning to asset managers to help them achieve sufficient investment returns to match the guaranteed performance on the wealth management products they have issued.
It sounds straightforward. In a low-yield environment, mainland banks are struggling to achieve the required returns for proprietary funds or wealth management products (WMPs) they sold to retail investors. The funds were traditionally invested into conventional fixed income instruments such as government bonds, but with local yields falling the banks have turned to outsourcing to boost returns.
“Yields have gone down and down since last year, and the banks have needed help from various experts to maintain [fund] returns,” said Miao Hui (pictured left), Singapore-based senior analyst at research firm Cerulli Associates.
But the solution is not as simple as it appears. The banks’ collective rush to outsource funds has seen huge amounts of assets being assigned to external managers. What's more, mainland institutions such as insurers and pension funds are handing out more mandates too, as generating returns become more difficult in a low-yield environment and they look to new types of investments.
The trend is such that Chinese bond fund assets grew 129% year on year – more than doubling – to Rmb1.15 trillion ($116 billion) as of September. But fund managers, like banks, face challenges in finding suitable yield.
Headwinds for banks
China’s equity market was gloomy throughout 2016, following a 25% collapse in January. The Shanghai Composite Index had only just topped 3,200 points in November, well under the 3,539 level where it had ended 2015.
Bonds have similarly disappointed. Demand has kept 10-year government bond yields below 3% throughout the year.
The lacklustre investment returns have led many retail investors to funnel money into WMPs offered by China’s commercial banks. It’s easy to see why; the products offer appealing guaranteed yields. A report by China Central Depositary & Clearing on August 31 estimated that they provided an average yield of 3.98% in the first half of 2016. Aggressive smaller banks sometimes offered up to 5%, said industry sources.
Rmb11 trillion in new money entered these WMPs between January 2015 and June 2016, causing them to reach a total value of Rmb26.3 trillion.
A shift in the mainland banking regulator’s stance on investable assets had helped accelerate the outsourcing push.
In the past, banks could gain high returns by investing into ‘non-standard credit assets’ (NSCAs) – typically packages of loans or debts used to finance infrastructure or property projects. Such assets usually fall into China’s shadow banking system.
But in July the China Banking Regulatory Commission (CBRC) issued rules restricting small and inexperienced commercial banks – defined as those with a track record in the WMP business of less than three years or with net capital under Rmb5 billion – from offering WMPs investing in equities or NSCAs to retail investors. That had a big impact, given that such investors account for 48% of the whole segment. As a result banks have had to look for better returns elsewhere – primarily in fixed income.
Earlier, in May, the China Securities Regulatory Commission (CSRC) had drafted new rules that tightened supervision of fund companies’ segregated-account (SA) subsidiaries, which mainly function as a channel for shadow banking activities. The regulator said it would require these SA units to hold more capital against NSCAs, which were deemed a particularly risky form of investment. That helped curtail capital from the banks into these subsidiaries, and meant the AUM of the 20 biggest such entities dropped by Rmb154 billion, or 2%, during the third quarter.
Liu Shichen (pictured right), an analyst at consultancy Z-Ben Advisors in Shanghai, said: “As the regulators have taken such a stance [in curbing shadow banking activities], many banks have cut their exposure to NSCAs. But they still need to find assets to invest in, so bond funds have become the most natural and safest choices."
Banks facing regulatory restrictions have had to focus on fixed income investing. That has left them with three options: add leverage, conduct opportunistic short-term trading and invest in lower-quality but higher-yielding credits.
But even large or national banks with internal investment teams may lack suitable investment capabilities for such activities. Hence many have turned to external fund managers to invest their WMP assets.
Industry participants said city and rural commercial banks had been particularly active outsourcers. They are smaller players in WMPs, accounting for 17% of the segment's AUM, but their WMP assets grew at 81% and 98% respectively in 2015, far outstripping the national banks’ 34% growth, according to a research note by SWS Securities Research.
“Many of [these city and rural banks] do not have an investment capability, so they need an adviser,” said a researcher for asset management at a city commercial bank. “Aggressive players are outsourcing 70% to 80% of their WMPs assets to fund managers, particularly small-sized banks in wealthy provinces like Guangdong and Zhejiang and cities like Jiangsu, Nanjing, Qingdao.”
It’s difficult to estimate exactly how much fund flows have migrated from commercial banks into fund houses, as neither those firms nor the regulator have released data. But analysts believe some statistics support their observations.
For their institutional SA business, Chinese fund firms have three main sources of AUM: the National Social Security Fund (NSSF), enterprise annuities (EAs) and other entities such as banks, insurers or corporates. Once the assets derived from EAs and NSSF are deducted, fund houses’ institutional AUM stood at Rmb5 trillion as of September, more than double the Rmb2.2 trillion of a year earlier, according to the Asset Management Association of China (Amac).
Beijing-based CCB-Principal, a joint venture between China Construction Bank (CCB) and US financial services firm Principal, grew its segregated accounts AUM by almost six times to Rmb630 billion in the first nine months, according to Amac. Cerulli’s Hui said most of this growth originated from WMP outsourcing from its parent, CCB. The fund house refuses to comment on its institutional business.
On the mutual fund side, mainland bond funds recorded net inflows of Rmb130 billion in the first half. Hui believes most of this entered a series of new bond funds, which raised Rmb122 billion over the same period.
Bosera is a typical example. The Shenzhen-based asset manager has set up at least 42 tailor-made funds – which are launched specifically for individual institutions and have seen strong growth – since last July. Its mutual fund AUM doubled from Rmb143 billion at the end of 2015 to Rmb288 billion as of September.
This is an extract from an article that appeared in the December/January issue of AsianInvestor magazine. Look out for the second part of this feature in the coming days.