China's fund management industry is relatively new, but has grown rapidly to $36 billion in assets under management. What themes are now dominant?
Alexander: The previous two quarters have seen declining interest across the board, and we're expecting much the same this quarter. Historically new fund offerings tend to slow dramatically ahead of the new year. Continued weak demand for new products, on the back of bearish sentiment in the equity markets and changes taking place in the industry structure, are also applying additional pressure on fund managers.
Is the launch of new products essential to revitalizing the market? And are the products genuinely differentiated, or are they merely a triumph of marketing?
Differentiation is now occurring to a certain degree, but the vast majority of products are still very similar in nature and follow a balanced investment objective. In some cases, such as Boshi fund management company, differentiation is being achieved by using a branding platform.
But we have seen some genuine new offerings this year, such as a convertible bond fund, money market products and guaranteed funds. The latter are obviously popular given the rocky performance of the domestic stock market.
As the number of fund managers increases, the need to differentiate products will build greater momentum. This is a positive for the industry and investors.
Obviously, the equity markets are vital to the development of the fund management industry. We saw the market hit five-year lows about a month ago before rebounding after the government committed support. Is this frustrating for market participants?
We shouldn't forget these are emerging markets. Equity prices have been extremely volatile of late and this is making it increasingly difficult to raise assets. In turn this is pressuring operating margins as fund managers generate the richer management fees from equity products. The market seems to be at an inflection point. It needs a catalyst to take off. But at the moment investors are waiting to find out whether the much-touted soft landing has actually happened or not. It's range-bound trading at the moment.
We're seeing some major fund inflows from China's growing institutional investor base.
Yes a new source of funds is indeed coming thanks to the launch of the national pension programme. It was originally piloted in the northeast. Fund management companies will benefit from these assets as paid-in contributions are outsourced to them. The National Council for Social Security is also reviewing mandates to manage its assets. There are eight possible mandates and for the first time, joint ventures have been allowed to participate. We're looking for at least two joint ventures to be awarded mandates later this year.
What's the main source of profitability for fund management companies?
Historically, profits have been derived from management fees, but with greater competition within the industry (more competing managers), downward pressure on fees is being applied. This is also being aggravated by shifting inter-industry relationships as banks and insurers begin establishing their own fund management subsidiaries. Insurers, for instance, are preparing to invest directly into equities rather than indirectly via fund products.
Distribution is also on the verge of change as fund managers seek alternatives to the dominating banks. This shift not only makes sense from a competitive standpoint, but also operationally, since banks are now pushing for greater share of management fees from managers if they wish access to the bank's network. Already, some distribution is being pushed through brokerages and alternative venues are now being considered.
We believe these changes are positive for the long-term development of the industry since banks' core competency is not playing the equity markets and insurance companies will not be allowed to raise funds from third parties. There is a natural inertia, which suggests that the impact will be moderate rather than a swift and dramatic.
This all sounds like the European model, where fund management companies are primarily owned by banks.
Yes, European banks dominate fund management processes and sell their own products through their distribution networks. But knowing the unpredictability of China's markets, I wouldn't necessarily bet on China following this model. What's clear is that with a diminishing take of the management fee and a slower take up of new products by retail investors, fund managers will need to dramatically alter their existing business model over the coming year.
There are a number of JV models now in China. How does their performance compare with local players?
They're perceived as being better run than the local companies. They, therefore, attract more assets than their domestic counterparts per new product launched - on average around $550 million versus $460 million. In spring this year, for example (JV) Fortis Haitong raised a stunning $1.58 billion in funds primarily from retail investors. That's the record so far. Fortis Haitong is also the most successful foreign company in terms of market share, lying seventh overall.
Of course, that's changing. In spring, markets were on a run, but since then, retail participation has dropped significantly to around 30% to 40% share of assets under management.
In terms of market share, defined as assets under management, the market share for JVs was approximately 9% at the end of last year, but now is just under 20% by our estimates. We expect this figure to climb over the coming year as new joint ventures enter and existing firms launch additional products.
How do they actually perform? Can they leverage on supposedly superior risk management skills?
They seem to outperform local companies. Equity products run by ING and ABN Amro, via their local partnerships, China Merchants and ABN Amro Xiangcai respectively, have shown some of the best results.
We've recently seen the launch of exchange-traded funds. What's their significance?
We believe the introduction of these vehicles is of great significance. The domestic equity market is bedeviled by the problem of what to do about the massive overhang of state shares. Just like in Hong Kong, these exchange traded funds could provide a vehicle for state-owned companies to unload their shares into the funds, which are then sold later to retail investors. We don't think it's a coincidence that State Street is working with the Chinese side. The group also worked with the Hong Kong government during the establishment of the Tracker Fund, which was used as a conduit to dispose of shares acquired by the government during the Asian Financial Crisis.