China seems set on delivering market shocks at the turn of a new decade. Not only has it decided to rein in excess liquidity by raising bank reserve rates, it has finally announced its plan to develop stock index futures, after years of delay. (No doubt held back by some of the failed experiments with bond futures in the 1990s.)
On the upside, the general belief is that investors should benefit from enhanced transparency, deeper market development, product enhancement, and so on. This long-standing list was set out by market observers and foreign experts years ago. There's no need to repeat it all here.
However, there is less consensus from consultants and fund-rating agencies on how stock index futures will affect the fund management sector. Analysts and research heads at Morningstar, Lipper and Z-Ben Advisors appear unconvinced about the ability of Chinese firms to manage these instruments.
Not that fund managers are authorised to join this new development yet. For now, only 11 authorised brokerages that have been approved to participate in the pilot schemes to trade the contracts have the qualifications to do so.
These 11 firms will only be able to express market views at an index level for the CSI 300 index. They aren't likely to be able to do much at the individual stock level. Indeed, regulators have said little about the actual schedule of the futures market's development.
The question then arises: If only vanilla instruments are available, will the futures market lead to product diversification for Chinese fund managers now trapped in the strait-jacket of a plain-vanilla world?
Maybe. Li Haiqing, fund analyst at fund-rating agency Morningstar in Shenzhen, says some primitive form of 130/30 strategies is likely to emerge in China. But that will happen first among the private funds that are not regulated by the securities regulator or are under the radar of the State Council's strategic plans -- not among the fund management houses. (Long/shorts, serious forms of arbitrage strategies, are something much further down the road.)
The best fund managers in China work for private houses these days, not mutual fund managers. Because they are not regulated, they are able to put together more flexible products. And they have the support of high-net-worth customers, who can take higher risks and have deeper pockets to support investments in trading platforms and risk management expertise.
The scene at mutual fund houses, meanwhile, is at best uneven. Xav Feng, head of research for China and Taiwan at fund-rating agency Lipper, reckons most fund houses have done "studies" on the new-fangled ideas of hedging tools. More are working their way up the learning curve, and most are simply not ready.
The lack of experienced people who can even understand the risks is a big worry. Talent supply simply to deliver good results from plain-vanilla securities is stretched, let alone expertise in innovative instruments.
Among the industry's 10 oldest mutual fund houses, for example, only three can claim to employ the local asset management industry's longest-serving fund managers. China Asset Management Company has Fang Jun, who served as a portfolio manager at China AMC for some five years and Han Huiyong for around six years. Shanghai's Hua An boasts Shang Jimin, who can claim a little over six years of experience. Harvest has Shao Jian, with close to six years.
There's an increasingly common polarised structure at these older firms, with a handful of senior managers at the top and a base of young managers with short track records. Hua An may have Shang Jimin, but other than Shang, there is a long list of individuals with experience ranging from around 20 days to little more than a year.
Similarly, at Shenzhen's China Southern, at the top there is Chen Jian, with nearly four years under his belt, and below him a group of managers, each with one to two years of experience.
"There is a long way to go," Lipper's Feng says. Apart from the talent factor, more importantly "there needs to be enough liquidity for index futures. If not, it would be a disaster for fund managers". Both Feng and Morningstar's Li reckon the underlying support of margin provisions -- the availability to secure leverage -- is key to the success of index futures.
As per usual in China, big securities reforms make great promises for the long term. In the short term, the picture lacks clarity and can be worrying.
"Index futures will increase the volatility of the Chinese market in the short term, because investors are not familiar with it," Feng says. But the market shock likely to come from the launch of futures might just be a stimulus for managers to strengthen their risk management techniques for the longer haul.
At present, Chinese mutual funds' risk exposure is overwhelmingly centred towards equity risk premium. Over the long term, theoretically, they would do better to diversify to other sources of risks -- for example, through credit, liquidity and manager skill.
Yet the reality is that managers have little business in asset classes beyond equities, which is their bread and butter, and managers are mostly unable to deliver returns purely through skill (the fabled search for alpha) that are uncorrelated from market exposure (beta).
Their only current means of managing risk is through asset allocation -- managers could sell equities and park their proceeds in cash, bonds or cash-equivalent instruments. (For that reason, overseas investors -- or reporters -- questioning Chinese managers about their risk management practices often proves futile.)
Stock index futures should help change that.
Zhang Haochuan, analyst at industry research house Z-Ben Advisors, has seen little movement in the hiring of professionals or in the investment in trading platforms specifically in preparation for stock index futures or margin trading.
AsianInvestor sources suggest Beijing-based Harvest and China AMC, Guangzhou-based E-fund and even Shanghai-based Hua An might have been the early movers. These firms have been trying hard to recruit quantitative risk management talent in Hong Kong in recent months, albeit sporadically.
Zhang says larger firms that have been caught in CSI 300 index fund launches over the past year will have more incentive and resources to mobilise suitable expertise.
There are 16 CSI 300 (largely identical) index funds on the market now. Two of these are enhanced products with built-in leverage.
As an unintended result of their multi-billion-renminbi launches last year, these 16 houses have more skin in the game than the rest of the industry. China AMC's CSI 300 product, for example, raised Rmb20 billion ($2.93 billion) in July. It is their business to start paying attention to these new concepts of securities innovation and risk management.