Fund houses may be rubbing their hands at the prospect of a new avenue into China’s market in the form of China-Hong Kong mutual recognition, but first movers are likely to face a distribution bottleneck, argues Cerulli Associates.
Foreign banks may not be eager to sell offshore products as they do not look like they can add much value to their fund range, said the Singapore-based research house in a new report.
That could result in problems for managers because demand for offshore investments in China has largely been driven by the affluent segment, which is mainly served by foreign banks.
Products offered under mutual recognition may not be as attractive for banks as qualified domestic institutional investor (QDII) funds, as they would likely be subject to more restrictions than the latter, Cerulli added.
That leaves onshore Chinese banks, which are powerful distributors. However, many Chinese investors in QDII funds were burnt by the financial crisis, so demand for offshore products might be lacklustre, the analytics firm said.
What's more, it takes time for these banks to train staff on offshore products. Therefore foreign asset managers with onshore distribution capabilities may be best positioned to benefit from mutual recognition initially.
That would be the likes of BlackRock and JP Morgan, which have stakes in domestic Chinese fund managers, or distribution capabilities in both the mainland and Hong Kong.
Another obstacle that fund firms face is that Chinese onshore investment products generally provide higher yield than foreign markets. Mainland money market funds offer returns ranging from 5% to 7%, and the trust-like products that domestic firms manage through their segregated account subsidiaries can yield as much as 10%.
A sample of 11 QDII global bond funds returned 2.13% to 7.49% as of the year to June, while a sample of 16 global equity funds returned -0.34% to 7.97, according to Morningstar.
Yet despite these obstacles, firms are preparing for the start of mutual recognition.
In June, the UK's Baring Asset Management announced plans to launch a Hong Kong-domiciled funds range, with an eye firmly on the pending launch of the scheme, as reported.
The announcement represented a considerable commitment by the firm to Asia and Asia-based product, because it has tended to develop Ucits product largely established in Ireland, which is available for sale into Asia.
And Barings is not alone, with the likes of BlackRock, Franklin Templeton and Vanguard making similar moves in the past year or two.
Chinese authorities have launched a series of regulatory liberalisations over the past two years, noted Cerulli. The Shanghai free-trade zone and increases in renminbi qualified foreign institutional investor (RQFII) quotas are two examples.
These provide managers with alternatives to the joint-venture model, which has run out of steam, as is reflected by events such as the exit of BNY Mellon from its China JV, said Felix Ng, a senior analyst at Cerulli.
The research firm predicts that Chinese authorities’ deregulation efforts will turn to the domestic front, especially risk management, product development and the rules surrounding the foreign ownership of assets.
Given that distribution and matching onshore yields may be challenges, Cerulli says it may pay to wait to be among the last movers.