International firms may now go solo in mainland China, but without mastering the local market, their new licences may yield little, writes Josh Bateman.
This year, China is forecast to account for 15% of global GDP. Its household savings rate is estimated to be 38%, more than six times that of the US. China’s mutual fund assets to GDP ratio, however, is at low double digits, a tenth of what it is in Australia.
As savers become investors, international asset managers are eager to access the Middle Kingdom. A popular strategy is to set up wholly foreign-owned enterprises (WFOEs), a method that allows global firms to maintain more control than they have historically enjoyed as minority partners in joint ventures.
Yet gaining a WFOE licence is not, in itself, a shortcut to success in China. Many challenges remain.
“The fascinating thing about China is there are so many possibilities,” says JP Morgan Asset Management’s head of China, Desiree Wang.
Her firm established an asset management WFOE last year in the Shanghai free-trade zone, where she says the local government is “very commercial and very supportive”. The firm could also have chosen the capital, Beijing, or Shenzhen, which aims to attract firms to its Qianhai free-trade zone. Between them, these cities boast a GDP of more than $1 trillion, double that of Sweden.
The firm’s decision, which came after years of market analysis, was not taken lightly. “We don’t rush in, we don’t rush out. And once we are in, we are in there for a long time,” she says.
Other global players are trying a similar strategy. Aberdeen Asset Management, BlackRock, Bridgewater Associates, Fidelity International and Value Partners have either received investment management or qualified domestic limited partner (QDLP) WFOE licences.
Fidelity used its WFOE to register as a private fund management company through the Asset Management Association of China (AMAC). BlackRock and Invesco Asia-Pacific have plans to do so. Registering with AMAC enables firms to offer onshore solutions to high-net-worth and institutional investors.
Almost everyone is optimistic about the possibilities offered by the Chinese market. “China is crucial to our global growth strategy,” says Mark Talbot, Asia Pacific managing director of Fidelity International. “This is a significant milestone to facilitate our expansion in the world’s second-largest economy.”
Yet there are difficulties ahead. Daniel Celeghin, partner at consultancy Casey Quirk, says many foreign managers underestimate how insular China is. “The vast majority of end buyers don’t know and don’t care who foreign managers are,” he said. “For the most part, there’s distrust.”
Foreign firms also underestimate the barriers facing them, he says. China’s largest private banks and securities firms often grumble that foreign managers, which aren’t familiar with Chinese investors and distributors, rarely make senior executives available, and send English and Cantonese-speaking representatives. They bring English marketing materials, which senior executives don’t understand, inducing “total humiliation”, says Celeghin.
To build credibility, Celeghin says firms should use WFOEs to establish local investment operations that manage Chinese securities. “If you want to be in the game,” he says, “you have to have local expertise.”
Celeghin argues China needs to be treated differently to markets such as Hong Kong, Japan or Australia. Fly-by pitches won’t suffice.
Having a WFOE is not an excuse to ignore other access routes to China, either. One of the reasons JP Morgan Asset Management registered its WFOE in Shanghai was to strengthen support for its joint venture, China International Fund Management, in which the majority owner is Shanghai International Trust. Joint ventures allow foreign managers to access the public mass market, which private fund management licences currently do not.
Keeping an open mind
“One difference between us and our competitors, we have a very successful joint venture,” says Wang. It’s “win-win,” she says, “if you deal with [joint venture] relationships wisely”.
It is important to keep an open mind because, as legal frameworks evolve, distribution trends do, too. Wang says offshore investment demand from sovereign wealth and national pension funds is being supplemented by insurance companies.
Historically, these institutions preferred to manage assets in-house, but they are increasingly outsourcing.
“They want to diversify into global assets,” she says, particularly alternatives and multi-asset solutions.
Amid this changing landscape, China’s fund market is growing. Brown Brothers Harriman estimated retail fund assets would be worth $4 trillion by 2025, up from $1.3 trillion in 2015. Banks dominate, but independent wealth managers, online and offline, have emerged in recent years.
Meanwhile, technology is changing distribution patterns. The 2013 launch of Yú’é Bao (‘leftover treasure’), an Alibaba money market fund that offers higher interest rates than banks, was an eye-catching example of how internet firms might disrupt the asset management sector. With $166 billion of assets, it is the world’s largest money market fund, a phenomenal feat.
Given the success of Yú’é Bao, other e-commerce companies are offering investment products in China. Many of these companies started out as peer-to-peer lenders but have morphed into quasi asset managers selling deposit products with seven, 15 and 30-day lock-ups.
Then there are alternative asset classes, such as private equity and US real estate, which Chinese wealth managers often use to entice prospective clients. Celeghin compares alternatives to a dealership’s sports car. “You might end up buying a minivan, but the sports car got you in the door and got you excited,” he says. “A lot of these mass affluent, they want to learn about this asset class.”
Another challenge within the Chinese market is that regulation is changing rapidly. Previously, many foreign firms reached retail investors through the qualified domestic institutional investors (QDII) scheme. However, a number of companies have closed their QDII funds with the aim of replacing them with products under the mutual recognition of funds (MRF) scheme. The latter scheme allows qualifying Hong Kong-domiciled funds to be passported into mainland China, while mainland Chinese funds enjoy the same treatment in Hong Kong.
JP Morgan Asset Management has had notable success under MRF. Its Asian Total Return Bond Fund has gathered more than 90% of of the scheme’s flows into northbound funds to date – that is, funds passported into China from Hong Kong – according to the company’s estimates.
Yet MRF hardly seems a panacea for foreign firms. Approvals under the scheme have dried up amid rumours that the Chinese authorities are concerned by the imbalance between northbound and southbound flows. Officials on the mainland, it is said, do not want to see more money flowing out to Hong Kong than is flowing in.
Another headwind, and another reason why local investors have strong home biases, is that yields within China remain high. Non-renminbi strategies account for less than 1% of retail assets, according to Celeghin.
And yield supersedes fee considerations. “It is may be the one large market in the world where there is no real fee sensitivity or even real fee awareness,” says Celeghin.
In addition, many retail investors are momentum-driven. High churn has nudged domestic fund houses to market non-listed strategies with lock-ups measured in months or quarters, not days.
Foreign firms do have some advantages. They can offer global solutions and foreign currency dominations, which most domestic players do not have.
Although uptake of these products is in the initial stages, Wang says that “demand for global diversification is very strong. And this lends some room for offshore managers to grow their assets”.
If Chinese investors’ offshore allocations were to increase from around 2% today to 5% or 10% in future, that would imply huge asset growth for foreign managers. There is clearly a great prize in China, but it will be hard to win.
2017 funds global asia