Summer 2010

MUTUAL FUNDS: Simple risks

RuletteThe Lehman Brothers downfall has scared Hong Kong investors, with many of them reverting to buying direct stocks and ETFs, finds Nick Fitzpatrick. When Terry Pan, the vice chairman of the Hong Kong Investment Funds Association (HKIFA), arrived home one night and a workman at his apartment block said that he was shorting the Canadian dollar through a leveraged futures contract, the conversation echoed discussions between chauffeurs and their Wall Street passengers reported just prior to the dotcom crash. Drivers had casually informed the besuited clients over their shoulders they had bought into hi-tech.
For the Wall Street bankers of dotcom folklore, retail interest in internet stocks was a signal to sell the Nasdaq. For Pan, the fact that a workman was playing currency futures made the educational programmes that he works on, both with the HKIFA and within his day job as head of Hong Kong business at JP Morgan Asset Management, all the more pressing.
Hong Kong and Chinese investors certainly have a spirit of adventure, though this is hardly surprising given the economic story of the region. They know what is going on in the Asian markets as much as Westerners do – and they too are buying into it.
But any notion that their adventurous spirit was not dented by the financial crisis due to their low levels of indebtedness falls down almost as abruptly as the collapse of the Lehman Brothers minibond scheme did.
The minibond fiasco took place in the wake of Lehman’s collapse and harmed some 40,000 Hong Kong investors. It led to 16 Hong Kong banks agreeing to spend more than HK$6bn (€0.6bn) to buy back Lehman Brothers minibonds from around 29,000 eligible customers. In return, Hong Kong’s Securities and Futures Commission (SFC) would discontinue its investigations into the sale and distribution of minibonds by the banks.
Mutual fund managers have been at war with banks offering structured products for years now, but the Lehman problem is said to have impacted the funds industry as much as it has the banks’ own product lines.
“People are scared and some of them have reverted back to type and started buying direct stocks and using ETFs [exchange-traded funds]. I do feel that an element of short-termism has crept back into the market,” says Alex Boggis, director at Aberdeen International Fund Managers. Surge in sales
Yet it is notable that Asian investors were a large source of inflows for the Luxembourg Ucits funds industry in early 2009.
It is also notable that fund sales in the region have surged again. In Hong Kong there are 2,093 authorised unit trusts and mutual funds available with a net asset value of US$628.30bn (end March 2008 – a nearer figure was not readily available). Net sales in March 2010 were $971.79m.
In the whole of the first quarter this year gross inflows increased by 252% over the corresponding period last year, equalling $6.425bn. Net inflows were $2.413bn.
Despite the minibonds problem, it would seem that Hong Kong investors are simply indomitable, particularly where their appetite for risk is concerned. The experience of Lieven Debruyne, chief executive of Schroders, seems to confirm this.
“Around 70% of our mutual fund sales a few years ago were equity funds. Although the percentage of bond funds has gone up, the interesting thing is that higher-risk bonds – such as high yield and emerging market debt – have been very popular.
“This tells me that, with volumes still being down overall, those investors prepared to buy funds are still willing to take risk.”
The absence of ‘newcits’ products, or hedge fund-type offerings that invest long and short, could account for the take-up of high yield and emerging market debt by people who want riskier investments.
Gerry Ng, managing director at Baring Asset Management in Hong Kong, says: “People here tend to go for higher volatility funds rather than shorting if they want to take more risk.”
He adds that Baring funds that have been popular in the region are Eastern Europe, global resources, global emerging market and high yield.
“The Baring Eastern Europe fund has been popular, particularly in Taiwan, where the fund is a household name,” he says, adding that the Baring Hong Kong China Fund is Barings’ best-selling fund in Hong Kong and the largest in terms of assets under management within the Barings stable.
Ng also says that he thinks the Lehman Brothers minibond issue will ultimately help mutual funds as people begin to differentiate between funds and structured products.
“The Lehman minibond issue in the last two years has upset a lot of people but it also made them understand that structured products are very complicated. This could be a positive development for mutual funds in the longer run.”
But despite the positive sales figures for funds, no-one is understating the damage done by the Lehman Brothers minibond fiasco to the mutual fund industry among retail investors. Whereas the average investor may well grasp the broad market outlooks for Asia versus Europe and the US – “Investors here are pretty savvy and pay close attention to what’s happening in the US and European markets,” says Ng at Barings – knowledge about how to play those markets through managed products rather than direct stocks still has some way to go.
Pan, at the HKIFA, says: “The investor probably does not differentiate between fund managers and other types of providers. They look just at the product and do not see any particular differences.”
In Hong Kong, and to some extent in the broader region, a wave of educational programmes is being rolled out.
The Hong Kong SFC has proposed the launch of an investors’ education council. Meanwhile, the HKIFA has launched its own initiative and an education panel forms one of its three working groups.
“The industry as a whole has been doing a lot of education in the past year,” says Pan, while his own firm, JP Morgan Asset Management, has held a series of brand-agnostic investor classes for members of the public to explain key nuts-and-bolts details about funds, such as the fact that assets are segregated from a fund manager’s balance sheet.
Notably, the unit trust subcommittee of the HKIFA, which has responsibility for investor education, also focuses on distributors, indicating that in Hong Kong, as in Europe, fund promoters feel that distributors also need to be better informed about the advantages of funds and the correct way to sell them.
Needless to say, the rapid turnover of mutual funds by investors in Hong Kong and China plays into the hands of distributors who sell them. But market players report that although distributors have been much more reticent to sell structured products following the Lehman minibond scheme, mutual funds have not filled the vacuum in third-party distribution channels.
One reason, of course, could be lower fees earned by distributors for mutual fund sales. Not that this has hurt ETFs, it would appear, and these tradable-indices products are a further challenge to managed funds.
Patrick Ho, managing director of iFast Financial, a financial adviser platform, notes that ETFs have seen an uptick in sales, despite the fact that those products also command lower margins for distributors.
“I think structured products will always be there and funds will be constantly facing challenges. ETFs are affecting mutual fund sales at the moment. Their volumes are quite high even though advisers do not make much margin on them.”
He adds: “ETFs will be very, very important in efficient markets. At the moment fund managers are finding it very difficult to outperform the markets, except in emerging markets where they can easily outperform indices with active management because the markets are less efficient.”
The Hong Kong regulator, according to Pan, who chairs the regulatory working group at the HKIFA, is working to standardise rules between structured products and mutual funds. In the meantime, banks see structured products as being taboo, and the regulator is signing fewer off.
“The issuance of new structured notes over the past nine months has been very, very little. In the past it was easy to launch these products to retail investors. A lot of issuers thought that a $20m deal would be sufficient for them but yield is so low now that is hard to do an issue that is attractive enough.
“Investment banks are not launching these products now partly for reputational reasons. Also, they are a little taboo with distributors.”
Pan adds: “Investors treasure the reputation of the product provider. They like a firm that has been working with the Hong Kong authority for a long time. Lehman Brothers had not been very transparent to Hong Kong retail investors, but at least it was
known to be the fourth largest investment bank in the world.” Staying local
Those brave Hong Kong investors that can put the Lehman Brothers minibond collapse aside and continue to invest (or rather trade, given the Chinese infamous tendency to turnover funds quickly) in mutual funds, then, are surprisingly still seeking risk in high-yield and emerging markets.
But the funds that look likely to sell well in the nearer future are generally targeting markets closer to home.
The recent inflows to equity funds were primarily registered by only three categories, namely Greater China Region equity, emerging markets and sector funds. Altogether, they pulled in $2.409bn, accounting for about 72% of the total inflows into equity funds.
“For China mainland investors looking to take advantage of the QDII schemes in the last few years, it is unfortunate that they had started to diversify outside of China, and then suddenly the world collapsed,” says Boggis, at Aberdeen. “This has resulted in a definite slowdown in QDII activity – which is a shame. The perception that there should be a stronger Chinese currency has also dampened investors’ enthusiasm, in this regard.”
Nevertheless, Aberdeen – which though mainly an institutional house in Hong Kong, also has a significant wholesale distribution too – plans to promote more US equity later in the year.
“Our strength is in stock selection and we can see that there are some great companies in the US, despite the macro issues. Our investment process for equity is already well respected and now utilised globally. We feel it is time to tell clients about the product, especially as a number of investors in Hong Kong have gone passive on US equity, which we intuitively think is probably the wrong way to go.”  
But now is not necessarily the time for workmen to go long on the US dollar through futures contracts. ©2010 funds global

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