US-based Vanguard, the world’s second biggest fund house, will use its direct no-fee online-sales model in China to bypass domestic banks and brokers – but some argue this approach could restrict its success.

Vanguard aims to sell its largely passively-managed range of products under the pending Hong Kong-China mutual recognition scheme, said Charles Lin, head of Greater China.

But the firm does not pay sales commissions to distributors anywhere in the world, in order to keep costs low, and Lin conceded this could make things trickier in the mainland.

“Distribution in China is still dominated by banks,” he noted. “If we don’t pay commission, it is a big challenge for us, but that doesn’t mean we are not interested.”

Vanguard has always been a ‘virtual’ company and does not have US offices that deal with retail investors face-to-face. It sells funds directly via its online platform and through financial advisers and is looking into such channels in China, which are evolving in the country, said Lin.

But while online channels are gaining in popularity, success will be restricted if a firm doesn’t pay distribution fees, noted Leslie Mao, director for investment services for China at consultancy Towers Watson.

“Retail and institutional investors in China like to compare products and shop around,” he added. “In that sense, success will depend on how wide the distribution platform will be. I do have a personal doubt on the no-distribution-fee model.”

He added, however, that Vanguard – known for its passively managed funds – could position the online platform as a trading tool so that retail investors can use its products to time markets. 

Ultimately, offering the right product in China is more important than the distribution channel, noted Mao. “Domestic investors can access wealth management products that offer 4-5% in terms of interest rate. To compete against that, offshore funds have to offer competitive yield.”

Still, electronic fund sales represent a growing trend in the mainland. Citing statistics from the Asset Management Association of China, Cerulli Associates said 58% of Chinese mutual fund assets under management were distributed by banks and 12% by brokerage firms in 2013, down from 64% and 13% respectively in 2012. In contrast, assets distributed through direct sales, as e-commerce platforms are classified, increased to 30% in 2013 from 23% in 2012.

Lin was optimistic that online fund distribution in China will continue to grow, adding that almost all asset management firms in China sell funds online.

About 83% of all US transactions under Vanguard’s institutional business (participants in employer-sponsored retirement plans) were made over the web in 2013 and 75% of all transactions in Vanguard’s retail business (individual investors) were made online during January to November of this year.

Expected to launch in the first quarter of 2015, the mutual recognition scheme will allow Hong Kong-domiciled mutual funds to be distributed in the mainland, and vice versa, under restrictions yet to be announced.

Vanguard opened its office in Hong Kong as Asia’s regional hub in 2011. It managed about $115 billion across the Asia-Pacific region including Australia as of the end of September. The firm recently surpassed $3 trillion in AUM and overtook Pimco as the second-biggest fund manager in the world.

Vanguard recently opened a Beijing representative office to explore opportunities and build relationships with regulators and asset management firms. It is expected that the mutual recognition scheme will require foreign asset managers to appoint a representative in China to be able to participate.