Why Beijing is targeting fund reforms at foreign houses
It may seem hard to countenance, but China’s asset management industry is just 21 years old.
Before 1998, no licenced asset managers existed. Institutions and the public deposited most of their money in banks, and investment fund products, if any, were unregulated, while the allocation of capital was inefficient.
But in recent years and particularly the past several months the country’s fund management industry has been awash with reform. The latest liberalisation came in July, when the State Council announced that fund management company (FMC) applications would be accepted in 2020, a year earlier than it had said in 2017.
The change would mean Beijing permitted foreign firms to apply for full ownership of their JVs from next year. Investment management wholly foreign-owned enterprises (IM Wfoes) could also ask to become a FMC, which would let them offer mutual funds to the general public, in addition to private funds.
International fund houses are keen to take advantage. They see plenty of opportunities in a country that advisory firm KPMG predicts will house the world’s second-largest asset management market by 2025. Canadian fund house Manulife Investment Management even described China as a “must-win battlefield” for its wealth and asset management business, when naming a senior executive to drive the operations in early June.
China’s willingness to throw the doors open to competition might seem a little odd, given Beijing’s often protective attitude to local companies. But there is a logic there. China’s asset management industry is dominated by a small number of players (in July its top 10 fund houses accounted for 44% of the total market share by assets under management), and local investors lack enough investing options. Increasing competition should drive product innovation, particularly around quantitative strategies, potentially benefiting institutional and retail investors alike.
But while China’s state policies are loosening, foreign firms still face a raft of challenges when charting their courses. Chief among them is the country’s unpredictable regulatory approval process, along with competition from established local fund houses.
“It (competition) will get fierce. They (foreign asset managers) will not win by competing head-on with established players in the market. They need to demonstrate superior expertise,” Stewart Aldcroft, senior advisor for the Asian fund management industry at Citi, told AsianInvestor.
China has introduced many changes in fund management in the past two months to further open up the industry.
Foreign fund managers began to enter the country in 2003, but for a long time they could only offer fund products to local investors via joint ventures, in which they were a minority party.
This began to change with the introduction of IM Wfoes in around 2015. Global fund firms could set up companies they directly owned by using this new structure, and then they could move to obtain a private fund management licence (PFM) from the Asset Management Association of China (Amac).
China gave out the first PFM licence to Fidelity in January 2017. Since then, 21 IM Wfoes have received the licences.
The PFM licences let foreign fund managers launch local asset-based private funds to high net worth individuals and institutional investors, but they could not create mutual funds. In addition, the Wfoes were barely allowed to invest in interbank bonds and couldn’t participate in the stock connect schemes linking the Hong Kong and Shanghai or Shenzhen bourses.
But from next year the State Council has said the Wfoes can pick up fund management company licences – 12 months ahead a schedule originally set in 2017. It opens up the retail investor base of the world’s most populous country. China’s asset management industry had AUM of Rmb13.35 trillion as of July, according to KPMG.
“This topic is high on the agenda of many global players because China is a market that no one can ignore,” Sally Wong, chief executive of the Hong Kong Investment Funds Association (HKIFA), told AsianInvestor.
And on August 9, one month after the State Council’s announcement, Amac announced that Wfoes could start investing in Hong Kong-listed stocks, while offering clearer rules on how the operations could invest in Chinese interbank bonds. That allows them to compete more fairly with domestic players – and further paves the way for Wfoes to eventually launch their own mutual funds, an analyst at a Shanghai-based consultancy firm, told AsianInvestor on condition of anonymity.
Unsurprisingly, fund firms have enthusiastically greeted news.
“China’s opening up of its private fund market is a huge opportunity … Now, with a full licence in sight, the other half of China’s fund industry would also be opened up to global asset managers,” Mark Li, general manager of Fullerton Shanghai, told AsianInvestor.
“Their investment scopes have been enlarged, enabling them to compete in almost the same way as domestic fund houses … this is a good thing,” agreed Rachel Wang, director of Chinese fund manager research at Morningstar.
Beijing’s motivation for opening up its fund industry appears to be fairly simple: it wants to encourage more product and service innovation and customisation than local fund managers can offer, particularly to its institutional investors. These asset owners held 45.4% of all fund shares as of June 2019, KPMG said.
“The emergence of foreign asset managers in China is helpful for institutional investors, because these managers will bring in more strategies from overseas markets and drive innovation in the domestic market,” Cliff Sheng, partner at McKinsey & Company, told AsianInvestor.
Foreign managers could particularly help offer new products that focus on absolute alpha and beta, which would help the institutional investors better meet their return targets for specific portfolios, he said.
Absolute alpha strategies, which target absolute returns, require complicated structures and modelling. Institutional investors like pension funds often lack such expertise and so offer such mandates to external managers. They have become more popular globally in recent years.
The entrance of more foreign managers means that a larger array of investment houses will be able to deliver on such niche strategies. In addition international fund managers also tend to be better than local firms at offering exchange-traded funds or smart-beta products, which target beta returns, he added.
While Chinese fund houses offer many traditional strategies like growth and value investing, foreign asset managers could seek to offer less developed alternative strategies such as multi-asset, absolute return and quantitative strategies. That would help to evolve this investment space in China, Leo Shen, wealth business leader for China at Mercer, told AsianInvestor.
The entrance of more foreign fund houses could even help expand the investible available investment universes. Currently investors are largely forced to invest in onshore assets, and there are many constraints over product structures and how they can use derivatives. But foreign players could use their offshore experience to lobby for and promote the innovation of new investment products, Shen added.
“It’s good to see more top-notched fund houses enter the China market as they can bring better investment management ideas to the industry,” Benjamin Deng, group chief investment officer of China Pacific Insurance Company, told AsianInvestor.
Introducing more foreign managers may also help to instill western investment philosophies, such as investment fundamentals over shorter term speculation. Building an appreciation of this approach would also benefit China’s capital markets, which are often very volatile, Wang of Morningstar added.
This story was adapted from a feature that originally appeared in AsianInvestor's Autumn 2019 magazine.