Why you should care
Global asset managers are spotting opportunities in China’s savings culture as the country opens up its investment sector.
When Chinese markets are in a slump, propaganda authorities often instruct official media to buck up investor sentiment. So it was in August, when the influential Securities Times trumpeted that international investors were “bargain hunting” in China’s stock market. The front page story was a backhand compliment that reflected the respect many Chinese investors pay foreign fund managers.
This air of expertise and prestige is perhaps foreign fund managers’ greatest asset as they seek to win a slice of what is forecast to become the world’s second-largest investment market — behind only the U.S. — within two years. With the global investment management industry suffering a near existential bout of anxiety from the rise of cheap passive funds, some now see China as their possible balm.
At a time when Washington and Beijing appear locked in a trade war, the potential opening of the Chinese investment market to American and other investment managers is one of the few areas where the world’s two biggest economies are building closer ties. China’s rapidly expanding middle class is prodigious at saving. The meager social safety net makes it imperative to stash money for old age, education or health care. As a result, the value of overall bank deposits, investments or insurance products has doubled over the past five years to $19 trillion at the end of 2017, and it will grow to $23.8 trillion at the end of next year, says Morgan Stanley.
To the frustration of Wall Street, the Chinese government has long restricted foreign access to this huge pool of money, with foreign groups limited to minority stakes in local mutual fund managers. Meanwhile, capital controls prevented both retail and institutional investors’ ability to place money with overseas asset managers.
China has only newly opened up, and only a tiny fraction of its potential has been utilized.
Bob Prince, Bridgewater, a hedge fund
However, after several small steps, Beijing announced in November 2017 that foreign groups could own majority stakes in domestic mutual fund companies — just as U.S. threats about imposing tariffs on Chinese exports were heating up. China also promised to allow full foreign ownership within three years. Given the potential of managing mutual funds for Chinese investors, this has triggered a frisson of excitement across the asset management industry.
“China has only newly opened up, and only a tiny fraction of its potential has been utilized,” says Bob Prince, co-chief investment officer at Bridgewater, a hedge fund that recently launched an onshore fund in China. “If global investors aren’t thinking about it today, then they’ll quickly be behind the curve.”
UBS forecasts that annual fees for running Chinese mutual funds will expand fivefold to $42 billion by 2025 — an enticing prospect for investment groups facing intensifying fee pressures and rising costs elsewhere. A $42 billion fee pot amounts to nearly two-thirds of the total 2017 revenues of listed U.S. asset managers — or more than Fidelity and BlackRock’s total revenues combined.
In his annual letter to investors this year, BlackRock chief executive Larry Fink identified China as one of the asset manager’s biggest long-term prospects. “There’s no safety net, so they are probably saving more than any other country in the world,” says Fink.
According to other asset management executives, many industry heavyweights are now scrambling to come up with a more ambitious China strategy. However, they stress that cracking China will be a long, arduous process. There is also the risk it could end up a sinkhole for foreign groups that pour in time and resources but have little to show for their troubles. That danger is aggravated by China’s trade dispute with the U.S.
Beijing, after all, is opening the door to foreigners for its own reasons: It wants to tame its wild markets and help develop domestic asset management. But the government is unlikely to countenance foreign firms dominating the market. The history of foreign business in China is littered with companies whose high expectations were never close to being realized. “Non-Chinese participants in a lot of industries thought that the Chinese domestic market would be like the Klondike [gold rush] for them, only to see domestic Chinese companies dominate,” says Jean Raby, chief executive of Natixis Investment Managers.
This summer, UBS began trimming more than 100 jobs from its asset management arm, which has $800 billion under management, including 30 roles in the U.S. — historically the industry’s biggest market. But in a sign of the times, the Swiss bank’s Chinese business was untouched.
The U.S. remains the biggest investment market, accounting for about half of the $50 trillion or so of global assets under management, according to the international arm of the Investment Company Institute, a trade body. But the fees fund managers can charge have come under pressure as investors have shifted hundreds of billions of dollars into cheap index-tracking funds. At the same time, the cost of necessary investments in compliance, security and new technology has kept climbing.
In this environment, the potential for tapping China’s vast savings is causing palpable excitement. René Buehlmann, head of Asia-Pacific operations at UBS Asset Management, declined to comment on the job losses but says China is a priority. “There is an enormous domestic market developing,” he says. “Progress has been remarkable, given the size of the market.”
Oliver Wyman estimates that assets under management at Chinese fund companies will grow 10 percent a year, from about $7.4 trillion today to about $14 trillion by 2023, when they will account for 15 percent of the global asset management industry. At the same time, the structure of the domestic sector is likely to change radically.
Currently, about two-thirds of the industry consists of low-margin money market funds — Yu’E Bao, the online fund run by Alibaba’s finance affiliate Ant Financial, is the world’s largest money fund — and wealth management products distributed by local banks and trust companies.
These wealth products account for well over half of the $19 trillion under management in fund companies, banks, insurers and trust companies. But they are risky structured-finance products masquerading as high-yield deposits. Investors get a quasi-guaranteed return from the bank, which in turn uses the money to make risky, off-the-books loans to circumvent capital adequacy requirements.
But last November regulators unveiled new rules that — once fully implemented by the end of 2020 — will ban these quasi-guarantees amid concerns over the expectation that state-owned banks would always shield investors from losses. Instead, wealth management products will have to be structured like mutual funds that are marked to market daily based on changes in the value of their underlying assets, thus ending the illusion of assured profits.
The withdrawal of guaranteed returns on commercial banks’ wealth management products will reduce their allure, allowing fund managers to compete with lenders on a more equal footing. Oliver Wyman therefore expects “traditional” asset management products to account for half of the $14 trillion domestic investment industry by 2023.
“The wealth management products are a controlled mess,” says one asset management executive. “But the authorities know what is going on, it’s not a secret, and the regulators want to wean people off them.”
Though years of complaints about barriers to entry helped prompt the recent measures, Beijing also wants foreign investment groups to help tame its retail-dominated, momentum-driven financial markets and nurture a more mature institutional asset management industry. In January 2017, Fidelity International became the first wholly foreign-owned group to register with China’s state-controlled industry association as a “private fund manager,” allowing Fidelity to begin selling funds to qualified investors.
Jackson Lee, Fidelity’s China country head, says the company’s commitment to China— especially its 500-strong back-office operation in Dalian — probably contributed to the regulator’s choice of Fidelity as the first foreign group to win a private fund licence. Yet, unlike many competitors, Fidelity decided against a mutual fund joint venture.
“Most of the JVs are run in a very local fashion. There’s really no sharing of day-to-day information, research and best practices. The foreign player mainly participates at the board level, not in day-to-day operations,” he says.
Fidelity’s move lit a fire under other firms uncertain about investing in China, according to Peter Alexander, managing director of Z-Ben, a consultancy that advises foreign asset managers in China. By late November, 15 of the top 50 global managers by assets under management had established wholly owned private fund entities, according to Z-Ben data. Of those, six have already issued their first products.
In April, the securities regulator followed up on the government’s promise from November 2017, issuing detailed rules that permit foreign groups to apply for stakes of up to 51 percent in joint-venture mutual funds.
But industry insiders suspect that the Sino-U.S. trade imbroglio may delay any U.S. applications. JPMorgan Asset Management has said it wants to raise its stake in its longstanding mutual fund JV with Shanghai International Trust, but is still in discussions to do so. Foreign executives say China routinely drags its heels on important approvals or uses them as diplomatic bargaining chips, even when companies meet the relevant requirements. A JPMorgan Asset Management spokesperson says it remains “committed” to expanding its onshore presence and talks are “progressing.”
Several foreign bank executives say Beijing could delay or prevent approvals to increase stakes in both fund management and securities joint ventures as a result of the trade war.
Some industry observers doubt that the private fund business can yield significant profits but should instead be regarded as a stepping stone toward obtaining a mutual fund licence that would allow the sale of products to the full universe of Chinese retail investors.
“It’s not as large in scope as the mutual fund client community, but it does provide us an opportunity to begin building our relationship with local distribution partners and have conversations with local advisers and their end clients,” says Ryan Stork, BlackRock’s Asia-Pacific head. He says BlackRock will eventually seek majority control of a mutual fund company but acknowledges the “journey towards majority ownership is going to take time.”
It remains uncertain how much foreign asset managers will be able to capture of the domestic market. Some groups fret that while China’s sheer size is enticing, it is too crowded and insular to be a realistic opportunity for foreign players for the foreseeable future.
“I don’t see where we have a comparative advantage managing money in the local market. Why would a local investor trust some foreigner to understand the Shenzhen stock market? It doesn’t make much sense,” says an executive at a U.S. fund manager that invests non-Chinese client money into China but has not sought entry into the local market.
Despite their differing strategies, foreign fund managers agree that success in China will require plenty of patience.
“It may sound like a cliché, but first of all you have to err on the side of caution,” says Min Yang, head of the China business of hedge fund Winton Group. “The Chinese market is its own special situation. The changes are fast and furious, so you need to do your homework and work with people who share a similar time horizon.”
Helping Chinese investors access foreign markets
Foreign fund managers have been banging on Beijing’s door for years to win a slice of the Chinese market. German fund manager Allianz and U.S.-based Invesco in 2003 became the first major foreign groups to establish minority-owned joint-venture mutual fund companies alongside Chinese partners. Others — including BlackRock, Credit Suisse, HSBC, JPMorgan, Morgan Stanley and Franklin Templeton — followed.
But for the next decade, progress on further market access largely stalled, even as the U.S. and E.U. chambers of commerce in China repeatedly asked for elimination of the joint-venture requirement in fund management.
In 2016, the U.S.-China Strategic and Economic Dialogue produced a commitment from Beijing to allow foreign groups to establish wholly owned “private fund management” entities. Such groups can sell funds to institutions and individuals with at least Rmb10 million ($1.4 million) in net assets. Since late 2016, 15 of the world’s 50 largest foreign asset managers have established wholly owned entities, according to Z-Ben Advisors, a consultancy.
For foreign fund managers, the most obvious competitive niche is helping to connect Chinese onshore money with global capital markets. But China still maintains tight control over outbound flows of portfolio capital.
Apart from the stock connect program that allows mainland investors to buy Hong Kong-traded shares, the main channel for offshore investment is the Qualified Domestic Institutional Investor scheme. Local funds can apply for QDII quotas to invest client money abroad, but these totalled only $103 billion at the end of October. Chinese fund companies control most of that, and with regulators engaged in a battle with capital flight, few expect big expansions to the scheme soon.
OZY partners with the U.K.'s Financial Times to bring you premium analysis and features. © The Financial Times Limited 2019.