It is a quiet afternoon at the Shanghai office of Nanjing Securities, tucked away on the second floor of an old building in the city’s Huangpu district. There is a queue of prospective stock market investors waiting to be served at the counters but it’s not a long one. The remaining people are scattered across the room, sitting on plastic chairs.
The demographic is distinctly middle-aged. In one row, a cluster of old women are knitting, their eyes moving between the clicking needles and the huge electronic boards that dominate one side of the room – one board for the Shanghai exchange and one for Shenzhen.
The only discernable buzz in this office comes from a group of six young women engaged in animated conversation. Their topic of choice is mutual funds.
“I only bought one fund but put in a large amount of money. At first it performed well, but later it was disappointing,” one woman said, when asked about her investment record.
This 27 year-old, who gave her name as Shen, quit her job in an electronics factory early last year. She explained that the decision to invest in funds and also directly in stocks came because she was looking for ways to occupy her time. It is also more lucrative than keeping money in the bank, she added.
As to whether she and other investors do enough research before making their purchases, Shen gave an unequivocal no. “Most of us don’t know anything at all before buying. We just follow other people’s advice.”
Head above water
Shen’s approach is similar to that of many individual investors in China. In a climate of rising prices, where the rate of inflation exceeds the standard rate of interest generated by a bank deposit, ever more people are turning – often blindly – to higher risk assets like stocks and property that can potentially deliver higher returns.
While investing in stocks is nothing new in China, the flood of money entering mutual funds in 2007 was unprecedented. By the end of the year, a total of US$451.8 billion was in the care of the country’s fund management companies, nearly three times the US$118.2 billion under management in 2006.
The question on everyone’s lips is how will investors respond to what looks set to be a more turbulent 2008 in which a 100% return on an equity fund becomes more exception than rule.
“This year a lot of companies, including ourselves, face a struggle,” said Peter Zhu, head of marketing at China International Fund Management, the joint venture in which JPMorgan Asset Management has a 49% interest. “Investors have just seen funds as an easy way to make money, but our performance won’t be so good going forward because the market will not rise as quickly as before.”
The big turning point for mutual funds was May 30, 2007, the day Beijing increased the stamp duty on stock market transactions from 0.1% to 0.3%. The Shanghai Composite Index (SCI) had risen by 62% during the month of May, but the stamp duty hike sent it plunging by about 20% in the space of a week.
“The average retail investor lost half his money because it was invested in questionable stocks,” recalled Peter Alexander, principal of fund management consultancy Z-Ben Advisors. “Then they noticed that the funds were only falling by 12% and so they got interested.”
He believes the lessons learned here could be even more pertinent in 2008.
“It’s not going to be like last year where you could your throw your money at Baosteel and make a pile. You have to be able to pick the right stocks.”
Z-Ben Advisors expects more moderate growth of about 40% in the mutual fund market in 2008, with total assets coming in at approximately US$635 billion. The first signs of a slowdown came in the final quarter of 2007 as new assets under management grew by just 5%. This period coincided with a 20% decline in the SCI. The bulk of the full-year asset growth came during the nine months to September, tracking the SCI’s 124% gain to mid-October.
However, those final three months did not see a fall in total assets, as many existing investors held steady. This is an indication of the positive feelings on stock performance in the year ahead. While market watchers agree that strong corporate earnings will continue to propel the index upwards, they warn that macroeconomic tightening measures implemented by Beijing may lead to more volatility.
“I think that Beijing’s monetary policy will impact the market,” said Zhou Liang, head of China research for fund intelligence service Lipper.
“The high prices in the property and stock markets are caused by too much money flowing in so the central bank will use credit controls, interest rate hikes and reserve ratio increases to rein in growth.”
One of the China Securities Regulatory Commission’s (CSRC) preferred control measures in the A-share market is banning the release of new funds. Although it has also shown itself willing to use fund launches to kick-start the market in times of trouble, the embargo stood for much of 2007 and is likely to remain in place well into 2008.
For all the fund management companies’ ambitious plans for new products, they may have to fall back on the principal innovation of last year: Pay out dividends to reduce the net asset value (NAV) per share of existing funds – i.e. make them cheaper – and do a reissue. This strategy saw the Yinhua Core Value Enhanced Fund boost assets from US$51.8 million to US$2.3 billion in 2007.
Here too, though, the regulator’s grip is tightening. Once a reissued fund has raised US$1.5-2 billion, it must now close to new subscribers for six months.
As fund managers apply themselves to the task of keeping the customers they brought in the last year, they will have to offer more than just equity market exposure. Money market funds – which saw a spike in demand in the last quarter of 2007 as the SCI wobbled – fixed-income bond funds, index funds and closed end funds could all play a greater role.
The ability to retain assets ultimately hinges on effective communication with the investors. This is a two-way process. The fund managers must spend more on after-sales sales service, recruiting and training more people to man their call centers; and the investors themselves need to take the information they are given and use it to develop coherent strategies.
Doubts remain as to their ability to do this, as Shen’s earlier remarks suggest.
“A lot of them have no clue at all,” said Leo Lei, manager of the Qualified Foreign Institutional Investor (QDII) fund at Fortune SGAM, the joint venture in which Société Générale Asset Management has a 49% stake. “Talk to any of the customer managers at bank branches and they will tell you that many individual investors just do what they are told.”
As a result, many of the fund management firms focus their investor education efforts on these customer managers.
Shortly after speaking to CHINA ECONOMIC REVIEW in early January, Lei, who was formerly Fortune SGAM’s head of equity research, caught a flight to Beijing. There he gave a one-hour presentation on sensible investment strategies that was broadcast nationwide via satellite link to staff at China Construction Bank.
“The customer managers are very important because they talk to investors on a daily basis,” he said. “We go on TV talk shows and publish articles in newspapers, but the main thing is holding conferences and seminars, as through these we can have direct contact with investors.”
China International began its investor education program in 2005 by hosting 100 seminars. This rose to 200 in 2006 and 600 in 2007. Representatives of INVESCO Great Wall, E-Fund and Hua’an Fund Management said they were engaged in similar activities.
Although most market watchers believe the situation has improved in the last two years, it is developing from a very low base. The road ahead is a long one.
“It is a huge job for the industry to better educate investors and there is still a lot of irrational investment behavior,” said Ed Legzdins, CEO of Bank of Montreal (BMO) Retail Investments, which owns 28% of Fullgoal Asset Management.
Viewed in this light, the CSRC’s efforts to assert a degree of control over the market appear justified. And it is not just the investors who require attention.
“In the third quarter of last year, US$6 billion was going into single products focusing on equities – can you imagine a Fidelity fund becoming that big in the West?” said Alexander of Z-Ben Advisors. “The CSRC is not trying to stifle the market but deliver manageable growth.”
The pace of industry expansion has already seen some firms experience growing pains. Executives didn’t plan for the business expansion that has taken place and this puts pressure on operations. While the competition for good fund managers and analysts is fierce, the problems actually stretch all the way up to chief investment officer level.
“Power struggles are happening and these operational issues have to be addressed,” said Alexander. “Five well respected CIOs left the industry last year to set up their own private funds.”
The most high profile departure was that of Lu Jun, who quit as CIO of China International for “personal reasons” in August 2007. Under Lu’s guidance, the firm saw its assets under management grow tenfold over the course of 2006.
According to one person familiar with the situation, the stellar growth “created operational frictions” between Lu and CEO Mandy Wang as Lu was effectively “outshining his boss.” It has been suggested that a CSRC crackdown on insider trading was leveraged to expose wrongdoing in Lu’s investment department – Tang Jian, a senior fund manager, was sacked in May – and ultimately forced him out of the company.
Compliance is key
China International’s own account of events is less dramatic. Peter Zhu, head of marketing at the company, said that Lu was keen to pursue lucrative opportunities in the field of private investment.
“We are a joint venture and compliance is playing an ever more important role,” Zhu added. “As a result, limits have been placed on our investments for the good of the company. Maybe some fund managers don’t like this style and therefore go into private equity where they believe they will have more freedom.”
The compliance issue offers an interesting insight into China’s joint venture fund management companies. Foreign investors are keen to introduce developed market-style oversight mechanisms to the enterprises in which they have an interest, yet it is one of several areas where tensions may emerge between them and their domestic partners.
Rex Auyeung, the Asia CEO of Principal International who brokered the US group’s joint venture with China Construction Bank, CCB-Principal, admitted that things were tough to begin with.
“It required quite a bit of discussion before all partners were satisfied that their views were being collected,” said Auyeung. “The management team has to understand shareholder thinking.”
In the last year, KPMG and PricewaterhouseCoopers have both carried out surveys of foreign fund management executives operating in China. Conflict between the long-term business growth objective of the foreign partner versus the domestic partner’s short-term, profit-oriented approach was a common concern.
The KPMG study attached particular emphasis to developing a common vision – on business strategy as well as the implementation of international best practices for compliance and risk management, even if it means the joint venture “might pass up on certain opportunities.”
In applying these principles, it is important to note the difference between a foreign-invested fund manager (there were three new investments in 2007, for a total of five) and one that is run as a joint venture (four new ones in 2007, making 22). For example, Deutsche Asset Management owns 19.5% of Harvest Fund Management but is said to be very hands-off in its approach compared to HSBC, which appointed the senior management at its joint venture, HSBC-Jintrust.
BMO’s Legzdins said his firm’s relations with Fullgoal are all the smoother because BMO is currently happy to be no more than a minority investor. “If they understand that we don’t have an objective for operational control, they feel much more comfortable asking us for assistance,” he explained.
According to research carried out by Z-Ben Advisors, the sometimes-conflicting priorities of parties involved in a joint venture may have an impact on performance. Although four new joint ventures were created in 2007, the market share of this group as a whole fell by one percentage point. While joint ventures accounted for six of the top 10 performing funds in 2006, this fell to just two in 2007.
Alexander believes there is more to the static performance than a regulatory bias towards domestic funds which means they can get their products out first.
“These joint venture companies aren’t able to respond quickly to changes in the market,” he said. “There is a sense that they don’t want to follow the flavor of the day but build a company in the long term. But this is an emerging market that is very fluid and so you have to be flexible.”
As an example, he cites the way in which the joint ventures procrastinated last year once it became clear that the CSRC embargo on new equity funds wasn’t going to be lifted. In contrast, domestic companies quickly began reissuing their existing funds.
Competition will only intensify as more foreigners enter the market. But the industry in China is still too young to write anyone off. Indeed, joint ventures can expect to prosper with funds released under the QDII scheme, where they can leverage the foreign party’s global markets experience.
What the 2007 performance figures do suggest, though, is that a blue chip foreign name counts for little. Funds live or die based on performance. As it stands, the honors go to local player China AMC, which manages the most assets and runs three of the top 10 performing funds.
“China AMC is a very smart player,” said Alexander. “They use their top fund as a flagship product but close it to new subscriptions. Then they go to their clients and say, ‘If you like this product, why not consider this other one?’ It is the most adept at meeting market demand.”
But this is still not enough for some people and back in the trading room at Nanjing Securities, the mood has become less buoyant.
Faced with a surging market and an investor base that focuses on the short-term (which means a large portion of assets must be held in cash to cover frequent redemptions), only 14 of the 180 equity funds managed to outperform the CSI 300 Index last year. This has left the assembled investors unimpressed by mutual fund performances.
“I won’t be buying any more funds; I think I will (put) my money into stocks instead,” said a woman named Hu, a 50 year-old retiree who used to work in a pram factory. “You can make money more quickly this way.”