It was supposed to be a breakthrough for Asia's asset management industry, but firms that have signed up for the Hong Kong-China mutual recognition of funds (MRF) scheme* may be waiting some time for the move to pay off.
Regulators on July 1 started accepting applications for the long-awaited scheme, sparking a generally optimistic response – after all, China's markets boomed in the first half of last year. Twenty-three southbound funds have been approved by Hong Kong’s Securities and Futures Commission, and three of 17 northbound funds have been approved by the mainland regulator.
But the mainland stock rout since the summer has dampened enthusiasm, as reported yesterday, and raises the question: will fund houses have to take a loss, at least in the short term?
The cost of entering the MRF scheme is hard to pin down, and buy-side firms are unwilling to put a price tag on it, seemingly largely due to uncertainty. Perhaps the numbers just look too scary.
Sell-side sources are more prepared to take a punt. “My guess is southbound funds will need at least $100 million [in assets] each to cover the first year’s costs,” said Stewart Aldcroft, senior adviser at Citi based in Hong Kong. “Unless there is a dramatic turnaround in China markets, which is always possible, a number of them will struggle to raise this in 2016."
"For northbound funds it is similar," he added, "but with fewer funds and broader investment objectives, it should be easier to achieve.”
Aldcroft forecast that sales of MRF products would fail to raise $1 billion in either the southbound or northbound schemes this year, noting that would make it economically unviable.
The consensus for northbound products is that 80% of total costs will go towards distribution and 20% to cover operational expenses. Research firm Cerulli Associates estimates that manufacturers are required to pay trailer fees for China fund sales in the range of 30-70% of management fees, which for an active mixed-asset fund are typically 1.5%.
Another issue is the nature of the market, dominated by the big four banks – ICBC, Bank of China, China Construction Bank and Agricultural Bank of China – which can all charge a premium.
“Bank distributors in China are notoriously greedy on distribution fees, leveraging their market share,” said Sebastian Chaker, Asia head at fund transaction services provider Calastone. “The big four command an estimated 80% of fund distribution, so they are in a position to ask for big commissions.”
Fund managers declined to comment on how much they pay mainland distributors in commission, saying it depended on asset size and confidential deals in each case.
Making an MRF business cost-effective will be a test, exacerbated by the 50:50 fundraising limitation in place under the scheme that restricts firms from raising more for a fund in one market than it does for the same fund in the other.
In January, boutique fund house Zeal Asset Management became the first to launch a northbound MRF product – the Zeal Voyage China Fund – in China. Its Hong Kong original has about $200 million in AUM, so it will only be able to match that asset base on the mainland.
“How do you stop a snowball going downhill halfway? Because that is what is going to happen if you have a $200 million fund,” questioned Aldcroft.
Many global fund houses, including UBS Asset Management and Franklin Templeton, do not have MRF-qualified, Hong Kong-domiciled mutual funds. To engage in MRF they need to have at least one with Rmb200 million ($30 million) or more in AUM and a one-year track record.
Aldcroft noted: “For big global companies whose daily fund flow is a billion dollars net, why should they be interested, knowing they can only raise Rmb200 million?”
One area of potential cost saving for the China market is online distribution, with a proactive social media campaign seen as essential.
Take LiCaiTong, a fund offering embedded in Tencent’s social media platform, WeChat. Tencent claims more than 30 million clients. Moreover, China’s largest asset manager, Tianhong, built scale via money-market fund Yu’E Bao on Alipay, the online payment platform of Alibaba.
But one deterrent of this approach is that long-only fund houses are seeking stable flows, and the ease of online buying and selling online is simply too fluid for many business models.
As for Hong Kong distributors, some are opting not to put MRF funds on their shelves, preferring to wait until investor appetite for China’s market returns.
The timing of the scheme’s launch can be considered unfortunate, with sources lamenting that MRF had not started several years ago, when China was booming. But that is not to take account of the scale of this operation, and the difficulties of aligning the two markets, one developed and the other still very much in a developmental stage.
The six months between the scheme’s launch and the first fund approvals afforded willing participants ample time to be ready to support live transactions. Market sentiment and investor appetite will always be changeable.
Better to focus on the potential long-term implications of this scheme, which are considerable. The pioneers are taking a risk, yes. But this is long-term money management, after all.
*AsianInvestor readers can find out more about the scheme by signing up for the Getting ready for the MRF webinar on February 17.