China is slowly and progressively opening up its investment fund market. How big of an opportunity does this represent for foreign fund managers?
The Chinese public mutual fund market stood at USD1.3tr at the end of 2015 and is the first market to reach that level without the aid of a defined contribution pension program. While growth has been fast (88% YoY growth in 2015 alone), foreign fund managers still can only access the domestic market through a minority stake in a joint venture. However, China is in the midst of major economic reforms which should not only open up the domestic market to foreign players, but also drive flows into the fund industry as bank savings are disintermediated into formal asset management channels. In the short term, foreign fund managers are finding opportunities in distributing their global products to Chinese investors through rapidly-expanding cross-border programs.
What are the most promising programs in China for foreign fund managers wishing to tap into the Chinese retail market?
The Qualified Domestic Institutional Investor (QDII) program has long been the best program for reaching Chinese investors and for a long time it was the only one. However, it is a more indirect way to access the market. Foreign managers can either partner with a local manager as a subadvisor or white-label their products for sale by banks or fund managers in a feeder fund structure. It is currently constricted by a lack of quota amidst a larger regulatory push to stem outflows. We see this as a hiccup in a longer trend of increased outbound investment and expect that more quota will be granted later this year to satisfy surging onshore demand. Mutual Recognition of Funds (MRF) is a new option which allows Hong Kong-domiciled funds to be sold on the Mainland. It has been relatively slow off the mark, but we expect this to become the primary channel for foreign managers to access Chinese retail investors and grow to USD140bn by 2021. Direct access to investors under one’s own brand is invaluable if approached correctly and participation in cross-border programs now will enhance a firm’s ability to maximize new opportunities further down the line.
Chinese retail investors have traditionally had a strong bias for domestic investments. In the context of RMB depreciation and Chinese market slowdown, how likely is it that Chinese investors will significantly increase foreign investment exposure?
These factors are indeed causing demand for offshore exposure to grow, which will drive money into QDII and MRF products in the long term. The single largest obstacle to selling international exposure in China has been buyers’ conviction that any foreign-denominated asset was guaranteed to lose value in RMB terms: that has now changed. A previously 98% (approx.) home bias is starting to waver, especially in regards to Hong Kong which is treated almost as an extension of domestic markets. As Chinese investors become more sophisticated in the long term, they will increasingly feel the need to diversify offshore, likely preferring USD-denominated products, but especially equity, index or high-yield bond products. However, mainland investors still lack understanding of foreign markets and products, and may be dissuaded by higher management fees and the relative lower performance of offshore investments.
Fund distribution in China is evolving very fast with online/mobile channels gaining significant traction. What distribution strategy would you recommend to foreign fund managers wishing to distribute via any of these programs?
The fund distribution landscape in China is shifting from one wholly dominated by banks to a more diversified range of options. Banks have wide and established networks, but IFAs and FMCs themselves are playing a greater role, and the emergence of online and mobile platforms makes a uniquely-Chinese environment for selling funds. Online and mobile platforms have the potential to reach the highest number of retail investors, especially those in younger age brackets, and will be the future direction for the industry. Managers need to understand and leverage the various platforms and channels to realize a successful distribution strategy, but must also not neglect investor and POS personnel education in addition to proactive marketing.
QDII2 will be the next major outbound program expected to launch this year. Will QDII2 be a game changer for foreign fund managers?
We would say that everything, and yet therefore nothing, can be considered a game changer in China, per se. The pace of change is so rapid, that the game is constantly changing. The next playing piece to be introduced, QDII2, undoubtedly has enormous potential, but only in the very long term. In its pilot phase, the program would lift the amount the individual investors are allowed to invest offshore in a variety of investment products and be regulated/executed via free trade zones and their infrastructure. Eventually, the program will be liberalized; participation thresholds should be lowered, and it should expand both in investment scope and geography. It is likely that outbound programs will converge as access widens, meaning that managers currently involved in QDLP and QDIE may be the first considered by regulators for QDII2 operations.
The first MRF funds have just started distribution in January 2016. Do you think MRF will be a key opportunity for foreign fund managers? How do you see MRF evolving in the next 3-5 years?
Thus far, we are the first to admit that the MRF program has been rather lackluster. Foreign brands are unknown on the Mainland and domestic distributors do not yet have the sales and servicing capability to distribute MRF funds. However, we believe that a program that allows firms to sell their funds in a new territory under their own brand name, which also taps into the growing demand for offshore exposure, has great potential for growth. We project that the program could reach USD140bn on the northbound side and USD100bn on the southbound side in the next five years, if certain liberalizations and developments were to occur. We expect that the program cap of RMB300bn (equivalent to USD46bn) in each direction will be raised. Geographic expansion within Asia could occur and mangers on both sides will have to quickly gain competency in a new market to be successful. Greater parity and integration will also have to be achieved across back office systems, KYC procedures, and regulatory operations for the program to mature. Eventually, MRF could even have the potential to become a third pillar of global fund regimes for the Pan-Asian region, alongside UCITS and the US ’40 Act.
HK based investors have already got a plethora of funds available to them to get exposure to the A-share market. What will be their appetite to invest in Chinese domestic funds?
We believe that demand will be low, especially in the short to medium term. Volatility of Chinese products, despite their high returns, will not likely attract investors in Hong Kong. Furthermore, most Chinese firms’ brand names are relatively unknown outside of the Mainland. The investor base in Hong Kong is also primarily institutional, which are not the key segment interested in the MRF scheme. While the scheme may not lure new investors to A-share funds, it will compete directly with existing funds as investors may prefer local managers to foreign managers who rely on QFII and RQFII for access.
There are multiple operational challenges when distributing funds in China. What are your recommendations to fund managers setting-up MRF products?
Operational challenges are best dealt with when operations have a certain proximity to the challenges. China is a market best dealt with hands on. Whether it be MRF or any other cross-border investment scheme, an onshore presence can be invaluable (even essential) to the long-term development of any China strategy. For MRF, having boots on the ground to carry out essential investor education, training of POS staff at your chosen distributors and brand marketing could be the difference between MRF success and failure, as we have seen with the first batch of product launches. Adjusting to China’s automated back office and complex regulatory systems will be another challenge, all the better coordinated from onshore. Cross-border integration of operations will continue to be a major difficulty in the medium term and establishing back office systems to cope with this should be a key consideration for global players. Furthermore, building and maintaining relationships on the Mainland can aid in crucial due diligence of potential domestic representative or distribution partnerships.
Analyst, Z-Ben Advisors
Ms. Baker joined Z-Ben Advisors in 2014 and her current areas of research and analysis include cross-border investment and the domestic mutual fund market. Jasmine works with the research and consulting teams to manage, produce and polish a range of annual, quarterly, monthly and daily multi-sector reports and actionable analytical updates to inform and advise clients’ China strategies.
Ms. Baker holds a Bachelor of Arts degree from the University of Cambridge and a Masters from Shanghai International Studies University.
Managing Director – Head of Asia, Calastone
Sebastien joined Calastone in 2010 to lead the firm’s international expansion. In 2012, Sebastien took responsibility for the Asia region, relocating to Hong Kong in 2013 to establish Calastone’s Asia regional office.
His career spans 20 years, and has been focussed in the investment fund distribution and servicing space. Sebastien started his career in 1996 in fund distribution at Citibank France, where he was in charge of Savings and Investment products, and worked on the launch of the CitiChoice fund platform. He then joined Euroclear in Brussels in 2000 as a senior product manager. In 2007, Sebastien joined Brown Brothers Harriman in London to head Global Funds solutions business development.
Sebastien holds a Bachelor’s degree in Economics from the Solvay Brussels School, Universite Libre de Bruxelles.