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In the two months of the year, before the China Securities Regulatory Commission imposed quotas on fund ôIPOsö, fund splits were rare. January and February saw only four funds split into new units, which sees net asset values (the total fundÆs value divided by the number of units) decline.
But since March, fund splits have become a major trend. There were four funds split in March, eight in April, and 11 in May. These splits slowed in June (only four, following a correction in the Shanghai stock market), but revved up again with seven in July; there have been four more in August so far.
Why this obsession with splitting fund units? It goes back to a long-held misperception among ChinaÆs investor base about NAVs. New funds in China are typically launched and listed with starting NAVs of one; these are known as ôone-kuaiö funds (kuai is a word used to denote quantities or units of renminbi).
Many investors are convinced that as a fundÆs NAV rises, in line with a fundÆs rising value, it becomes too ôexpensiveö to buy, regardless of future growth opportunities. It is therefore difficult for fund management companies to sell existing funds because they tend to have NAVs above one renminbi.
Yao Bei, senior marketing manager at Fortis Haitong Investment Management in Shanghai, recalls a typical scene from his companyÆs educational seminars for retail clients. After he and his colleagues painstakingly explained every concept and every detail in investment, one of the first questions was inevitably, ôHey, do you sell any one-kuai funds?ö
Until recently this was not a big deal because ChinaÆs industry has been built around new launches, with plenty of redemptions that churn into the next hot fund IPO. But when the CSRC began putting limits on new launchesÆ asset gathering, the idea of selling existing funds caught fire.
There was also the problem of size. When fund houses such as Harvest Fund Management sold $5 billion funds in the space of a day, as happened last December, they are under enormous strain to invest those assets and perform.
ôThere is a limit to what a fund manager can buy in blue chips,ö notes Pearl Chen, business director at ChinaAMC in Beijing, currently the largest fund house by AUM. ChinaAMC, like others, has had to put a stop to asset gathering for three of its funds that invest in large-cap stocks because the size became too unwieldy.
The problem is particularly acute for ChinaÆs ôold-10ö fund companies, including ChinaAMC and Harvest, which are among its biggest. But for smaller, young fund houses, fund splits are also attractive as a means of generating new assets. Fund management companies have embarked on a fund splits, calculated so that NAVs return to one renminbi.
Alternatively, they will hand out large dividend payments; there have been 81 dividend payments paying more than RMB4 per share so far this year, none of which were prescribed in the offering documents. These were also all followed by secondary offerings once the NAV had been recalculated at par, providing fund houses with an easy way to gin up new sales.
But is this good for their investors?
Fund houses say yes. ôWe reward our customers who have supported us in the past,ö says Zhang Lei, a marketer at BoC International Investment Managers in Shanghai, which split a fund earlier this month. ôThe NAV had become too high.ö She says the split allows more investors to afford getting into the fund at a lower price.
Splits certainly benefit the fund management companies, by allowing them to gather more assets and command greater management fees. But some critics say original investors in a fund suffer.
ôShareholders have nothing to gain from a secondary offering or downward adjustment of NAV whatsoever,ö says æHow HowÆ Zhang Haochuan, product analyst at Z-Ben Advisors in Shanghai. ôPaying a huge dividend may have a negative impact on a productÆs return, as the manager is forced to sell securities to raise the cash.ö
Slashing NAVs also encourages churning: investors paid a hefty dividend are more likely to put that money into a new fund in the hopes of earning another big payout or NAV rise later. Distributors are happy with high turnover, and fund splits make it easy for unsophisticated bank staff to sell the ôcheapö product; but the transaction costs will harm investors over time.
It also distorts how funds are rated by credit rating agencies, which makes the market less transparent. Performance calculations using NAV have to be changed, making apples-to-apples comparisons among different funds more challenging.
ChinaÆs remains young and retail-dominated market lends itself to this practice, says Herbert Zhang, CIO at China Universal Asset Management, a new fund house in Shanghai. He notes the continuous run of massive IPOs û China UniversalÆs debut fund raised RMB100 billion in one hour û will encourage the kind of speculative behaviour that underpins the ôone-kuaiö fund obsession.
ôWe still have a long way to go in terms of investor education,ö says Andy Liu, vice director at Guotai Asset Management. There is little that fund execs can do to change this pattern, he says. The costs of teaching so many people about the technicalities of NAV pricing amid the heated environment of a bull market would be very expensive. And, he notes, ChinaÆs example is not unique. ôMarkets mature on a trial-and-error basis,ö he says.
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