Mutual distrust

Investor confidence has surged back to China's stock markets this summer, with prices and trading volumes warming to the call of the government. However the nation's fledgling mutual funds industry has wilted in the heat, a casualty of the central government's failure to inform individuals about the long-term benefits of investing in a pool of stocks rather than in individual companies.

The first signs of a market rally came in June following the seventh cut in interest rates in less than three years. Soon after the People's Daily, the mouthpiece of the Chinese Communist Party, published a front-page commentary praising the market surge as “reflecting the wealth and economic reality in the country.” Officials from the industry's top watchdog the China Securities Regulatory Commission (CSRC), including its chairman Mr. Zhou Zhengging, have also been making positive comments in public.

Government officials had hoped that the combined effect of the rate-cut and the stock market rallies would persuade people to shift their money from banks to stocks.

However continued volatility on the local bourses in Shanghai and Shenzhen has already scared off many ordinary investors. The Workers Daily, reporting the luke warm investor reaction to the rate cut, quoted a bank depositor as saying: “Playing stocks is too risky. I cannot afford to buy a car or a house. Depositing my money in the bank is still the safest.”

China's first proper mutual fund to be regulated by the CSRC was launched in April 1998. Today there are a dozen such funds which should be benefiting from the uncertain macroeconomic climate which exists in China today. Rising unemployment and sluggish economic growth continue to erode the sense of financial security among ordinary people. In these conditions it is the stock market, not bank deposits, that is more likely to provide long-term capital growth and protection against inflation. Internationally, mutual funds, which aim to invest in a wide range of stocks to spread risk and maximise investor returns, are a popular vehicle for the financially conservative.

When the first closed-end mutual funds, Jintai and Kaiyuan, were launched last year, the unit price shot up by 60 percent from their issue price of Yn1.01 within just 10 days. The issues were 40 times oversubscribed, attracting combined subscription funds of Yn160bn (US$19bn). Since then public interest has waned. In April this year, two similar new funds managed to attract only Ynl6bn-worth of subscription money.

Critics say that the funds have under-performed the market when it is bullish and fared worse during bearish times. To exacerbate matters for investors, they pay a management fee of 2.5 percent of the net asset value, one of the highest rates in the world.

During the current media campaign, regulatory officials have for the first time spelled out measures being taken to supports trust the domestic mutual funds industry. For example, they are working closely with legislators to pave the way for foreign fund management companies to set up B-share funds and joint venture funds in an attempt to bring in international expertise.

For the two latest funds listed in Shanghai and Shenzhen, management fees have been cut to 1.5 percent of the net asset value. But managers may be able to claim a one-off performance-related reward if they are able to meet four criteria: keep the average annual net asset value per unit above par; achieve a return on funds that exceeds the one-year bank deposit rate by at least 20 percent; record net asset growth that exceeds the average return of the stock markets; and ensure that the net asset value per unit does not fall below par after distribution of profits to investors.

Long-term investors
Despite these improvements, the listed funds have not proved popular among investors. "Unlike unit trusts in the West, our mutual funds are closed-end with a maximum life span of 15 years," says Mr. Zhang Lei, a Shanghai resident who dabbles in the stock market. "Therefore the unit price is not determined by the fund manager on the basis of inflow and outflow of investors' money. Instead, the price mirrors the volatile movement of the market. So people do not see the point of buying into a mutual fund."

New mutual funds tend to come onto the market during good times, just like the stocks themselves. "We all know that the current surge has no economic basis and will not last long," adds Zhang. "As soon as the market is up, we hear about new issues coming on stream. That seems to be the game plan."

Mr. Ju Xin Xing, company secretary of the B-share company Shanghai International Travel Agency, says that in trying to persuade people to shift their bank savings to the stock market, the government has forgotten to cultivate a new breed of long-term investors. "It seems that the government is unconsciously encouraging punters because everybody knew that a short-term rally was very likely [after the People's Daily article]."

When stocks are hot, he says, nobody is interested in mutual funds. He complains that the CSRC has failed to promote the new vehicle from the point of view of the investor, instead emphasising the need to create institutional investors to curb market volatility.

"Through official media, the government told investors not to churn mutual funds like stocks, but they have never launched an effective campaign to list the benefits of mutual funds," Ju observes. The initial success of the funds was based largely on the public perception that the government controlled and supported them.

The fact that all mutual funds have to publish their holding details on a monthly basis ensures transparency but, at the same time, it deprives the market of rumours which are the engine of so much price movement. "That's why punters don't like them, and we all are punters now," says Ju.

Developing a fund management industry in China was always going to be a long process. Without a clear plan to educate the public and introduce foreign expertise, mutual funds are unlikely to win widespread investor favour in the near future.