After Bank of Communications (BOCOM), Industrial and Commercial Bank of China (ICBC) and China Construction Bank (CCB) were hand-picked in February 2005 to start China’s first bank-led fund management joint ventures, the authorities must have been pleased with initial results. BOCOM’s maiden fund launch with UK-based Schroder Investment Management raised US$610 million in August, topping the US$550 million raised earlier that month by ICBC and Credit Suisse. Outdoing them both was CCB’s joint venture with Principal Financial Group, which raised US$767 million in September.
This success was hardly surprising. China’s domestic banks have been heavily involved in fund distribution on behalf of independent fund houses, where their comprehensive branch networks made them integral to the market’s development. But it also meant they had easy access to a vast pool of potential investors to make a spectacular splash on entry.
They soon made an equally spectacular crash. The ICBC-Credit Suisse Core Value Fund lost 51% of its assets under management in the first quarter of 2006, dropping from US$493 million to US$240 million. The fund’s experience followed an identical pattern to that established in the previous quarter by the BOCOM-Schroder Selective Fund, which lost 49% in assets in the three months to the end of December 2005, falling from US$610 million to US$312 million. It now has less than US$250 million under investment.
In both cases, analysts blamed losses on the domestic bank partners, claiming that most investors were guanxi clients, asked to invest in return for previous favors or future preferential investment. The joint venture funds refuted the allegations.
At the time, Credit Suisse told the Financial Times the losses were a natural by-product of investors taking profits following a strong turnaround in China’s A-share market during the first quarter. However, a spokesperson for BOCOM-Schroder, who asked to remain anonymous, said the banks themselves may even have suggested clients cash in their gains, making the money available for reinvestment in deposit-bearing accounts.
According to Linbo Fan, Greater China senior research analyst for fund intelligence agency Lipper, the banks had no great desire to enter the equity-oriented fund business. Given their main driver was to retain money flowing from their bank deposits to other fixed income instruments following the introduction of mutual funds, their interest was biased towards money-market funds.
But regulators, looking to give equities markets a much needed liquidity boost during the reform of state-held non-tradable shares, tied the banks’ hands. In 2005, pure equity funds represented only 9.4% of total assets under fund management, although mixed-asset funds add another 43.4%. At a combined value of US$30.9 billion, these equity-orientated funds represented more than 20% of the market value of tradable stocks, but an unofficial halt was put on approvals for new money market funds. As a result, more than half the new funds added during 2005 were equity-orientated funds, with very few money market funds launched after July.
Interestingly, BOCOM-Schroder, ICBC-Credit Suisse and CCB-Principal, have all now been approved for and launched money market funds, although details are scarce. According to press releases on their websites, BOCOM-Schroder launched a money-market fund in December, and ICBC-Credit Suisse raised US$1.09 billion with its equivalent service when it started up in March. Both offerings followed hot on the heels of losses in their respective equities-orientated funds. In theory, a strong opening is proof enough for the regulators that the banks belong in the market.
Regardless of what type of funds the banks explore in the long-term, their ability to make such an impact on the developing industry is bad news for independent fund companies like China Asset Management, E Fund, Boshi, and Huaan. With domestic banks likely to favor their own funds, these companies will need to develop new distribution channels for their own.
On the up
The market has already grown incredibly fast in the last few years and competition for investors has increased accordingly. The total number of registered fund companies climbed 16% in 2005 to 51, while 57 new funds were introduced into the market, taking the total to 218, an increase of 35.4%. However, there is growing interest in alternative investments, with total assets under management reaching US$58.6 in 2004, up 44.3%. Open-end assets under management climbed a staggering 58.3% to US$48.3 billion, from around only US$5 billion in 2002.
Rules on foreign ownership constraints on joint-ventures have also been relaxed, resulting in even more competition. The total number of joint-venture fund companies grew from 13 to 20 in 2005, while the number of domestic fund companies dropped by one to 31. The impending entry of insurance agencies into the mutual funds market is likely to take the intensity of competition to a new level.
Lipper’s Fan said competition would improve the product range, particularly with domestic banks likely to dominate money-market funds. To survive, independent fund companies need to explore niche areas like pure equity funds. "Now the competition is getting more furious, they have to somehow distinguish themselves from others," said Fan. "They have to look at demand at a more refined level to identify where a potential niche could be for a particular product."
Potential for further growth is almost unlimited. Mutual funds represent around 2% of China’s GDP, while bank deposits account for around 88%. As one of a number of emerging alternatives to the bank deposit system, mutual funds can expect to grow fat off the middle-income population’s high propensity to save.
As combatants jostle for position, headlines screaming massive launches and equally massive declines need to be taken with a grain of salt. Domestic banks have given the market a well-needed shake-up, showing there is money out there looking for new means of investment. But the banks have also shown they will not let it out of the money markets without a fight.
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