Making funds work in China

Denis Lefranc, GM of Fortune SGAM Fund Management talks about the challenges facing foreign fund managers in China.

SGAM has achieved some pretty respectable results in the two years since its inception: one billion dollars under management, over twice the figure in December last year; and returns of up to almost 19% on certain of your funds. How challenging has the process been?

Lefranc, It's not been easy, especially after the SARS epidemic last year caused much of the market to grind to a halt.

However, the take up in our funds has been extraordinary. There's clearly enormous appetite out there for this type of investment products, both with us and other fund managers.

Were they are any major problems setting up in Shanghai?

We are based in the Jinmao Tower in Pudong. That's not just for marketing purposes - the building is one of a relatively small number of buildings, which we believe is equipped up to our standards in terms of being able to provide the necessary IT infrastructure to handle our complex back office functions.

It's more complicated than in Europe, since it's impossible to outsource all the IT functions as the market here is not sufficiently developed. We have to do it all in house and fly in experts from our other Asian offices to supervise. That was quit a headache, but it's all done now.

Are your investors mainly retail or institutional?

In China, a clear distinction between retail and institutional does not exist. They both buy into the same funds. That's because - at least for the time being - institutional investors are not allowed to grant mandates.

What's the significance of that?

It means institutional investors cannot make specific agreements with fund managers on how they want their money invested, separate from the funds. When that changes, we believe that the amount of funds we manage will go up sharply.

That should be to our advantage, because we have the experience and skills to work out the exact risk-return ratio, tracking errors and so on, that investors need.

Indeed, local investors and foreign observers might imagine that foreign funds would be far better than local funds, based on superior techniques of risk management and back office operations. How true is that?

That's an interesting misperception. The Chinese fund management industry has responded very rapidly to foreign competition and on many levels is on a par with foreign firms. Just take the stock exchanges of Shanghai and Shenzhen - they are completely automated, and the local fund managers have been forced to install the IT infrastructure to handle that.

In addition, the local houses have been active in the market for many years now. The worst excesses of their growing-up period have probably passed. The biggest local fund management companies are now staffed by skilled professionals with the best equipment. They've also benefited enormously from technology transfer agreements with Western fund management companies interested in getting a foothold in the country.

What has actually happened is that the sector in China has been able to profit from 'globalization' and skip many of the stages of development which characterized the evolution of the Western fund industry.

Do you feel there is a genuinely a level playing field in the fund management industry, or does the regulatory environment still tilt in favour of Chinese companies?

Yes, there are regulations which prevent us from leveraging our biggest strength, our expertise in designing new products.

In China, local and international funds are only permitted to launch two funds per year. This limitation ends up preventing us from breaking away from the pack and it muffles the dynamism we could bring to the sector.

What about your joint venture partner, Bao Steel. It might seem odd to outsiders that you are partnering with a steel company.

Yes, we currently have 33% of the joint venture with Bao Steel's financial services subsidiary, Fortune, but we hope to increase that to a majority stake when World Trade Organization rules permit us. Bao Steel is an enormously profitable and powerful enterprise, one of only a handful of genuinely world class Chinese companies.

It's a member of the Fortune 500, for example. Thanks to its size, it also has numerous connections with Chinese banks, who are falling over themselves to lend to such a company.

What advantage do you derive from that?

A crucial aspect of fund management is the distribution of our products. Through Bao Steel, we have meet numerous banks and discussed different models of 'bancassuarnce' with them, whereby their staff sell our product in return for a commission. We've ended up working closely with China Construction Bank.

Still, it's a tough market: The number of fund management companies has exploded in the past few years, but the number of state banks that can distribute our product effectively has stayed exactly the same!

What about your own personal role within the organization? How do you balance the need for developed economy-level standards in risk management, investment returns, reporting, back office functions and overall professionalism with the need local knowledge - or perhaps street wisdom might be more accurate?

My job, first and foremost, is to supervises and enforce standards in all the areas you have just mentioned.

However, although I have been here for two years, I make no claims to being an expert on the local A-share market. Unusually, our chief investment officer, who is a local Chinese with many years of market experience with both foreign and local firms, has an absolute power of veto on investment decisions - that is, he can overrule me.

When it comes to 'localization', we agree that it's desirable. But we are not looking for fresh MBAs with two years work experience! We're looking for mature individuals with up a to a decade's worth of accumulated expertise. Our senior executives are all in their early 30s, for example.

You come from a very analytical culture. How transferable is that in China, where the markets so often ignore the basic economic situation, but respond strongly to political signals?

We try to ignore those non-market gyrations. You may remember in December last year, there was a huge run up in the stock market, due to some comments out of Beijing. We were criticized for not joining in the scramble. But we did not think the fundamentals warranted such enthusiasm, and we stayed on the sidelines. Our customers were grateful when the market fell back to earth in the early part of this year.

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