Interview with Z-BEN Advisors on changing fund landscape in China

Leo Chen, Managing Director - Head of Asia

Blog / 17 May 2018

Calastone’s Head of Asia Leo Chen interviews Z-BEN Advisors’ Jasmine Baker on some of the key topics affecting the fund landscape in China this year, including cross-border investment schemes, digital distribution and the maco-economic climate. 

L – Leo Chen, Managing Director, Head of Asia, Calastone

J – Jasmine Baker, Senior Associate, Z-BEN Advisors

L: The Hong Kong-China mutual recognition of funds (MRF) scheme has hardly set the heather on fire since its launch in 2015. How do you see its value for global fund managers as an outbound investment channel?

J: The value of MRF really differs on a firm-level basis, depending on long-term China aspirations. For those looking to target China’s mass retail, MRF is a great way in; and currently the only way. The fact remains that there are now global managers selling their global products in China, which was not possible before MRF, and those have already seen net inflows of over RMB12 billion (USD1.9 billion). Building any business is tough and takes time, but especially in China where the demand, market, distribution and regulatory environments are all very different from home. Yet, for those with a long-term view, MRF allows managers to start creating distribution networks, understanding investor demand cycles and even building a brand.

The value of these gains cannot be underestimated. MRF is the most viable program for fund managers to be considering for an outbound business in the nearer term. Interestingly, recent regulations state that commercial pension funds will be permitted to invest into MRF products – which may bring a boost to AUM over the next few years. However, it is true that, in context of the wider opening and new China business opportunities coming onto the table, the potential of MRF may be overshadowed as managers re-engineer their China approach and pick between the many new options.

L: Apart from MRF and other cross-border investment schemes, are there any recent developments encouraging foreign fund managers to access China’s asset management market? Who is currently involved and how have they progressed in actual fund sales?

J: China has now opened its gates to allow foreign firms to run money onshore under their own banner. Although they will not be able to target retail investors just yet, they can sell domestically-manufactured product to HNWIs and institutions via private fund entities – the long-term potential of this entry path is the ability to obtain a retail fund management license after a few years of operation.

In the space of a year since this key liberalization occurred, we have now seen over 30 global firms entering, five of which (UBS GAM, Man, Fullerton, Value Partners and Fidelity International) have already launched private fund products. Although there is no disclosure on fundraising so far, we expect that many of these managers will begin by tapping onshore affiliate capital until they build out broader HNWI relationships and grow to a threshold to interest China’s institutional investors. Managers which have been operating with fund joint ventures or Qualified Domestic Limited Partnership (QDLP) entities will have a significant head start.

L: MRF products are only a very small part of the fund market onshore. How do you see China’s fund market growth over the next decade?

J: From only USD450 billion in 2007, Z-Ben Advisors projects that the retail fund market will grow to USD12 trillion by 2027. This may sound ambitious but, if you can consider that it has reached its current size of almost USD2 trillion without defined contribution pension flows, the pension system reforms kicking off over the next few years will trigger explosive growth. Tax incentives expected in 2018 and regulatory support for fully-developed commercial pensions by 2020 will push assets in this direction; leading us to expect industry AUM 40% composed of pension flows in ten years’ time.

China’s capital markets will also continue to mature, introducing depth and breadth across equities and fixed income, attracting long-term investors and greater foreign participation, while retail investors continue to become more sophisticated in their attitude towards diversification and risk-adjusted returns. MRF will also benefit from these shifts: we project it should grow to around USD30 billion in the next five years. Finally, this is not only a big and growing market, it is also a profitable one. Considering that the fund business has generated an around 30% net profit margin annually for those involved, we expect total industry profits to reach USD32 billion by 2027.

L: What mobile or online distribution platforms exist in China and what are their AUM?

J: Z-Ben Advisors estimates that 62% of distribution was online in 1H17. In the same period, WeChat (Tencent) with its 963 million active users was shelving financial products and Tianhong’s (Alibaba) Yu’E Bao became the worlds’ biggest money-market fund (MMF), mainly distributed online due to its user-friendly link to Alipay. Beneath the numbers, though, the story is more complicated. These tech giants currently lack know-how in selling financial products and their platforms want for investor education functionality. Despite the huge potential, it will be a long road until they even approach optimum utility.

Meanwhile, online IFAs have fared slightly better: there was a 41% increase in the number of mutual fund products distributed by Tiantian (Eastmoney) between 1H16 and 1H17, and the AUM of funds distributed in the latter period was RMB158.6 billion (USD25 billion). Rival Howbuy saw an almost 100% year-on-year increase in registered mutual funds, but only secured a 1H17 AUM of RMB10.4 billion (USD1.6 billion).

Robo-advisory platforms, such as Eggroll and Snowball, are so far only able to offer vanilla products in a limited selection of simple portfolios. Perhaps the strongest links are the banks and brokerages, traditionally the dominating distribution forces in China, which are beginning to build out their online and mobile ecosystems and robo-advisory services. In summary, online or mobile distribution is not yet a silver bullet for global managers – it should be leveraged as part of a much broader onshore distribution strategy.

L: China enters 2018 with robust economic-growth momentum, despite the high levels of debt and central bank tightening last year. What significant shifts do you see that will open up more business opportunities for global managers?

J: China is now fully committed to allow foreign majority ownership in the fund management sector. In combination with the Wholly Foreign-Owned Enterprise (WFOE), there are now multiple paths to control of an onshore China business, minimizing partner risk which previously kept so many global managers at bay. At the same time as this opening, both the speed of growth of addressable assets and improving regulation are factors encouraging China business development. Coordinated regulatory shifts have and will continue to introduce greater transparency, better standards and less risk across all sectors of the asset management industry in China.

Global managers will be entering a much healthier market moving forward. One part of that has been the crackdown on shadow banking, which will eventually push trillions of assets into both the private and public fund segments. Although the global narrative surrounding China is often negative, reforms are nudging the industry in the right direction, slowly but surely, and global managers are finding that China is too big to ignore. In fact, we project that by 2027, global managers will make up 25% of China’s mutual fund market.


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