Luca Frontini: When I came to China three years ago in 2003, I could see the immense potential of the markets. We looked for a Chinese domestic brokerage, û medium-level, medium-size, medium-everything in fact! We found one, namely Guodu Securities, our current partner. For our part, we (the foreign shareholder) are a listed, medium-level Italian regional bank with very strong fundamentals, but looking about for the next growth opportunity. We are currently going through a merger process which will make us (depending on how you measure it) the fourth-largest bank in Italy, so a proper national player with a larger international presence. Our market cap will double to Ç15 billion, and our name will change to UBI û United Bank of Italy. Following the merger, we will have the third-most assets under management in Italy.
Did you drive the deal?
Yes. The whole process, from the day I stepped off the plane to having our current office in Shanghai Jinmao Tower, took nine months, thanks to a very short decision making process at our bank.
Do you have a China background? ItÆs impressive that you saw the potential of the A-share market in 2003, when the market was dire.
I have dealt with China and Asia on a professional basis, in my previous function as a portfolio manager. But in any case, it was clear that if you are asset gathering, this is a great place! There are not many places for the money to go, given the closed capital account and dearth of investment options. Rmb10 billion funds are very common here. ThatÆs large by any measure. I used to work for a very large investment company and we only had one fund of Rmb20 billion. All the others were in the range of Rmb5 billion, partly because itÆs hard to manage bigger funds due to liquidity reasons.
How is the market?
ItÆs remarkable. Funds are being launched and being greeted like IPOs. This morning we heard of one fund raising billions of renminbi in under one hour.
How hands-on are you?
I come from an investment background, so I am certainly interested in where we invest. But I donÆt do the actual investment allocation. When I came, I was very busy with dealing directly with our future partner. We saw more than 20 potential partners, including brokerage houses. After that, I had to oversee the actual physical operation of the venture. Nominally, I am CEO, but in fact, IÆm far more hands-on than a CEO should be, in a way. I try to participate as much as possible, but our portfolio manager, Ian Midgely (formerly from Huaan) has sole responsibility for making the investments. ThatÆs to ensure corporate governance. Basically, I try to square the circle in terms of dealing with the competing demands of the different operations in our office.
One thing that I was very clear on was that we had to accept an equal level with our Chinese partner. The Italian partner is not a giant. But while the industry is not very old here in China, we are very accustomed with the practice of investment. We have three senior foreigners working in China. The third is from our Italian operations. All my other people are local. Speaking of staff, itÆs extremely difficult to get staff, but thatÆs the price of a booming market. Everyone is well-paid so itÆs hard to hire. So you are driven to poaching from your competitors. You also have to resign yourself to having to train people.
WhatÆs your take on the markets now?
We have seen a wonderful earnings growth story. So the fundamentals are in place. In fact, they are improving. The structural problems of the market have been cleared up. The government has addressed the share reform process. IPOs are coming to the market; the capital markets now seem to be working as they were meant to work. As for the macro situation, everyone keeps saying it will crash. Well, we are still waiting. ItÆs certainly an emerging market, but what makes it unique is that itÆs such a huge domestic that it can withstand international shocks. Many analysts complain about the lack of consumption in the market. But I would rather switch the question and ask: What is more difficult, to stimulate consumption, or to have a huge pool of savings to finance growth? Clearly, itÆs the latter. Plus, you have an 8% trade surplus, which a lot of people criticize. For me, thatÆs a pretty good problem to have. ItÆs like someone complaining that a football teamÆs front line has Von Basten, Maradonna and three other top goal scorers.
Why are mutual funds so popular at the moment? Surely itÆs cheaper to just buy the stock directly.
The point is that itÆs still a minority of investors who buy funds, but a growing one. But they realize it makes sense to allow professional managers. If you had bought shares three years ago in a mutual fund, you would make serious money today. If you bought single shares three years ago, you would most likely have lost your money. So people are learning the diversification of risk argument.
Retail participation is picking up again û and thatÆs the key to the whole industry. And it still has a long way to go. Institutional money can go in and out, but retail tends to be æstickierÆ. Retail investment is based on a longer time horizon, which is the right one to have for China. You are buying the macro picture here, so three to five years is a good time horizon, with earnings growth up 20% per year.
As for valuations, they could be an issue in the short to medium term. When stocks are expensive they are prone to a correction. And that can be bad for sentiment. But even if price/earnings ratios are high, what choice do local investors have? They canÆt buy GermanyÆs DAX. ItÆs the same story as we keep hearing about real estate: itÆs going to crash, itÆs going to crash. And mysteriously, it doesnÆt.
Is it going to crash? No, the fundamentals are good. But because the market is expensive, which means limited upside, we could see a correction. The market might trade at P/E of 40 times, but that doesnÆt mean a big problem. Not all companies trade at 40 times.
One of characteristics of the Chinese market is that itÆs policy driven. When something needs to be done, the leaders will do it. They have a pretty good track record for making the right call. And people listen to them. ItÆs not in anybodyÆs interest to let things go out of control.
WhatÆs your feeling about the stock you trade?
ItÆs a mixed bag, but itÆs improving. Transparency and accounting are all improving. Some companies prefer to list in the US because itÆs quicker, but itÆs not easier. And Chinese companies now have no problem adjusting to this. But the macro environment is so positive that I believe it will feed through eventually. You do have a problem of too much money chasing too few companies, however. The market will take time to develop.
Do you believe China is the æEldoradoÆ?
Interestingly, I donÆt. I donÆt see many people who have made lots of money easily. ThatÆs actually quite reassuring to me. You have to put in the effort, and you will reap the rewards. But itÆs fascinating to see the market building up from the ground up.
I gather you yourselves have done very well in fund raising.
Yes, we launched a fund in January, raising Rmb6.9 billion. We closed the fund prior to the expiration date, because we didnÆt wan to raise too much money, as that might affect our investment. We timed it well and we had good performance. Our fund was not the largest - we canÆt compete against local banks. But we marketed through Fujian Industrial Bank, certain securities houses and the post office. Frankly speaking, we were still too unknown for the big banks to work with us û but we proved that even without them, a new company could do very well. 95% of launches are with one of the four state-owned banks. But big funds are far more difficult to make good returns on. ThatÆs a crucial point. You have to protect our investors and we donÆt want too much money. ThatÆs why we closed our fund early. It was a hard call to make.
WhatÆs your investment philosophy?
We are active managers and fundamental driven. We are not like Fidelity doing a bit of everything. We want to try to identify what we are good at, and focus on that. In five to ten years, I believe we will have a very clear image in the market. We will be more of an equity investor than fixed income, I suspect, although we will give our clients that option. Of course, we canÆt compete with local giant like ICBC. We are all here to take what we can and offer a good service. We are not like HSBC, which wants to be amongst the top players and who need economies of scale. We only focus on this area and can afford to be niche player.
Are fees the same as in Europe?
They are very much in line with the industry. They are set by the regulator. They are close to international standards. Everyone charges the same, pretty much.
There are two basic models: you have profits generated by a highly effective marketing and distribution network, which is the European model, or you have the US model, which is more driven by track record. In China, given the history is pretty short, itÆs more the former model that we are following.
There is variance on the fees you pay for distribution. It would be unfair not to mention that the investment company enjoys better margins than in a mature market, where the distribution fees are greater. The assets are also growing so fast here, compared to a mature market. The margins here are fatter, and itÆs less competitive than in mature markets. As a result, itÆs a very profitable business, with margins perhaps higher by 30-40 basis points compared to Europe. Essentially, we are in a sweet spot where assets are rising very fast, but margins have not yet fallen. They will, though.
But that profitability is very important for the future health of the market, otherwise nobody would be interested in building up a custody business, for example. When the local banks start recognizing how much of their P&L comes from the stock market, they will invest in the industry. Most the big banks have already recognized this and are setting up their own investment companies.
Nevertheless, things are getting more competitive very fast. You have 50 companies launching 100 funds per year. Luckily, they are raising money off $2 trillion in savings. ThatÆs huge, but you have to ensure that mechanism of transferring the money from the savings to the markets works smoothly.
This growth will lead to a greater variety of investment instruments. At the moment we donÆt have any stock futures (we do have commodity futures) and we donÆt have much shorting. When you invest in a market with little liquidity, not having stock futures makes the problem a lot worse. So there are problems, but China is still a sunny place for the industry. Still, donÆt forget to wear a lot of sunscreen.
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