Published on Published on CCFA Journal of Finance, August 2020
Two hundred years ago, a huge ship drifted slowly across the Atlantic Ocean. The vessel was manned by the Dutch, and filled with spices from India, timber from Norway, silk and ceramics from China, and, of course, no small amount of treasure. People celebrated their arrival.
Sea trade is always full of dangers and unknowns, meaning every successful return can rest on the role of a dice. Made in Amsterdam, the ship was collectively funded before the journey. Then, a man named Adrian distributed the trade profits in proportion.
This was the first closed-end publicly offered fund in the world, aptly named “Unity is Power”.
Twenty-two years ago, China’s first closed-end funds were launched and snapped up like lottery tickets. This marked the beginning of the Chinese fund management industry.
The Chinese Fund Management Industry: Layout and Supervision
According to statistics from the Asset Management Association of China (AMAC), by March 2020, there were 143 publicly offered fund management companies on the market, managing 6,819 publicly offered funds with a total scale of RMB 16.64 trillion (USD 2.35 trillion). Comparing this with 2009, when there was less than RMB 3 trillion (USD 0.42 trillion) in publicly offered funds throughout the entire market, there has been a fivefold increase in just ten years.
Narrowing this down to the specific types of funds, money market funds account for half of the amount, followed by bond funds at 18.54%, equity and hybrid funds 8.47% and 12.67% respectively.
Over the past four decades, China has witnessed rapid economic development, numerous investment opportunities, high returns on investments, and consistently high risk-free returns on capital. For example, trust product return rates once reached 15%-17%, bank wealth management products (WMPs) generated stable return about 6%-8%. Over time, residents have developed a habit of “rigid redemption.” In contrast, as emerging market, the domestic capital markets are prone to acute fluctuations. As a result, investors who lack any professional investment knowledge and have no concept of how to invest in the long term often find it difficult to make any profit, which in turn hinders the development of equity funds. In April 2018, China’s New Asset Management Rules were implemented, and the “net-asset-value approachand rigid redemption break-down” policy was put in place. Meanwhile, as the risk-free return rate keeps falling, the cost effectiveness of risk assets has gradually become more apparent.
Source: Asset Management Association of China, as of 03/31/2020
The fund management industry is probably the most well-regulated sector in the Chinese asset management industry. There are more than 210 laws and regulations relating to the publicly offered fund management industry, covering areas such as research and investment, risk control, marketing, clearing operations, information systems, and legal compliance. These regulations exist in order to encourage open and transparent sharing of information, full risk disclosure, accurate customer recognition, and clear operational processes. The fund management industry has become the role model for other asset management institutions to aspire to during their transition, such as bank asset management firms, bank wealth management subsidiaries, and trust companies.
As a standardized financial product featuring leading systems and standardized operations, publicly offered funds have become an important wealth management tool for household asset allocation. Publicly offered funds play an increasingly crucial role in supporting the real economy and capital market reform. Two major changes have occurred as part of efforts to further push supply-side reform in the financial sector, promote real economy financial services, and effectively reduce leverage and control risks. Firstly, the China Securities Regulatory Commission (CSRC) enacted China’s New Asset Management Rules in order to rectify the chaotic practices that exist in the asset management industry, such as rigid redemption, cashpooling, and passageway business. This aimed to create a new era for net-asset-value products. Secondly, in October 2019, the CSRC optimized the registration procedures for public fund products. This provides speedy registration on conventional products for fund managers who have a high degree of integrity, sturdy compliance risk controls, and promising mid- to long-term investment performance. This came in an effort to streamline administration processes and decentralize power. At the same time, the CSRC has strengthened ongoing and follow-up supervision, and established a special task force to carry out spot checks and reviews, ensuring that the application materials provided by relevant fund managers are authentic, accurate and complete.
The government also pays close attention to phenomena such as the large concentration of homogeneous products, an emphasis on raising capital instead of capital management, drastic changes of fund size , and actions that do not help protect the investor’s interests. Since October 2019, the policy orientation of “expanding direct financing and reducing leverage” has been reflected in the approval rate of equity products, which has been significantly higher than that of fixed income products.
The outbreak of COVID-19 has challenged the normal operation of the fund management industry. In one respect, employer safety and system stability have become the top priorities; and additionally, due to travel restrictions, company visit research and market development have been affected to some extent. At this time, it is especially vital for fund management companies to have an emergency plan and disaster recovery system, meticulous processes and rigorous executive ability, and a bold, proactive team. The epidemic has also further highlighted the importance of digitization. For example, many roadshows have moved to online livestreaming, and a great number of research activities have been conducted in the form of teleconferences and video conferences. For Rosefinch Fund, digitization is one of the three established strategies that allows us to better cope with the impact of COVID-19.
The Enlightenment of American Fund Management Industry Development
The century-old US fund management industry reached a value of USD 25.7 trillion by the end of last year, accounting for half of the global total. Divided by their pace of development, the 1970s and 1980s were the watershed in the history of American funds.
Source: Huachuang Securities, ICI, 2018
If the 1970s was the beginning of American financial innovation, the 1980s was its culmination. The AUM of mutual funds rose from USD47.6 billion in 1970, to USD 134.7 billion in 1980, then to USD 1.0652 trillion in 1990. The number of mutual funds rose from 361 in 1970 to 3,079 in 1990. Structurally, money market funds took the lead in this rise, but in the late 1980s, equity funds became the rising star. Meanwhile, the no-load fund was born and the Investor Advisory Service emerged.
During this period, the mutual funds were able to flourish based on changes such as the US dollar decoupling from gold, financial deregulation, the entry of pensions into the market, and tax breaks on equity gains.
Since then, the development of mutual funds in the United States formed a positive cycle, starting with the creation of tax preferential policies to promote the market entry of pensions. This then promotes equity financing, improves corporate earnings, strengthens the economy, increases the stock index, and successfully achieves pension market entry. Individual pension accounts, in particular, provide long-term funding for US mutual funds, promoting not only the development of institutional investors, but also the transfer of household assets to the securities market. According to Investment Company Fact Book 2020, 45% of existing mutual funds are equity funds, 21% are hybrid funds, 11.8% are bond funds and only 6.9% are money market funds. 45.5% of households hold mutual funds, a tenfold increase from 5.7% in 1980.
In China, publicly offered funds only account for 3.5% of household assets, with money market funds accounting for 60% and equity funds less than 30%, far below the levels seen in the US.
However, there is also cause for optimism. Similarly to the US in the 1980s, over the past few years China has been advancing a series of capital market reforms. We have constructed and improved the three pillars of pensions to promote the use of pension and enterprise annuities to enter the market. In order to continuously improve the basic capital market system, we have launched STAR Market and the New Third Board selection floor, as well as implementing the new registration system for the STAR Market and the Gem Board. We have further opened up the capital market to foreign investment and removed foreign shareholding limits. We have promoted financial supply-side reform and intensively developed direct financing. Using the rapid development of the US publicly offered fund management industry in the 1980s as our point of reference, we believe that the Chinese publicly offered fund management industry can expect to see greater opportunities for development, based on the previous 22 years of development.
Current Status of Chinese-Foreign Joint Venture Fund Management Companies
Of the 143 institutions in China with publicly offered fund licenses, 43 are joint ventures, accounting for nearly a third. As of December 31, 2019, the assets managed by Chinese-foreign joint venture fund companies totaled RMB 7 trillion, which is half of the industry. In 2019, according to incomplete statistics provided by Wind, the operating incomes of the 20 Chinese-foreign joint ventures (with revenue data) were all positive. Of the 26 Chinese-foreign joint ventures (with net profit data), 25 had positive net profit. The specific distribution is as follows.
Statistics show that the profit of Chinese-foreign joint ventures are distributed in a clear hierarchy, with great differences between each level. Among the top 10 institutions, there are three Chinese-foreign joint ventures, namely ICBC Credit Suisse Asset Management (RMB 1.536 billion), CCB Principal Asset Management (RMB 1.238 billion), and China Asset Management (RMB 1.2 billion). If we observe this top level of high-profit companies, we can see that what they share is a high degree of localization, meaning closer integration with the Chinese market. In terms of investment, this means that research into the combined features of A-share listed companies can help to discover value. With regard to capital, we can observe the demands from different types of investors and provide the appropriate product solutions for them.
以1990年交易所开市为起点，今年A股迎来而立之年。尽管与海外市场相比还很年轻，但中国的资本市场不乏自身特色。对于计划进入中国的海外资产管理人而言，我们认为最重要的是“When in Rome, do as the Romans do. ”（入乡随俗）无论是合资还是独资企业，充分了解中国市场的特点，包括资本市场制度、法律环境、资金属性、资产特征等方方面面，才能更好地发展。
If 1990 marks the birth of the Chinese stock exchange, this year, A-share companies have now reached its thirties. Although still a newcomer in comparison with overseas markets, China’s capital markets have their own unique characteristics. For overseas asset managers planning to enter China, we believe the key thing to remember is “When in Rome, do as the Romans do”. Whether they are a joint venture or a wholly-owned enterprise, they should do their utmost to properly understand the Chinese market, including the capital market system, legal environment, capital attributes, asset characteristics and so on. Only by fully understanding these features will foreign investors be able to achieve substantial development.
Of course, in the gradual process of opening up financially, the influence of foreign capital over A-shares will gradually increase. At present, the current market value of A-shares is RMB 28.7 trillion. Excluding long-term funds such as major shareholders and industrial capital, the actual free floated market value is around RMB 15 trillion. If foreign capital flows in at a rate of one trillion yuan per year, it will become the key marginal incremental capital on the market.
Fund Investment Advisory Reform
In April this year, the CSRC published the Administrative Measures on Securities Funds Investment Advisory Business (Draft for Comment), which is currently soliciting opinions from the public.
The purpose of the fund investment advisory reformis located at the sales level, wherein we should share the same perspective as the buyer, acting as their investment consultant rather than a sales representative for the seller. The main focus of a sales approach is to serve the seller (fund companies) by distributing their fund products and receiving commission in return. Conversely, the focus of investment consulting is to provide the buyer (fund investors) with advice on how to allocate their assets, charging them consultancy fees for this service.
Compared with the traditional method, investment consulting mechanisms help buyers distribute their capital into the most reasonable fund products available, working to avoid the situation where the fund makes money, but the investors are losing money. On one side, we should be improving investors’ sense of fulfillment from investing. On the other side, we should be safeguarding fund managers against interference from short-term fluctuations, and focusing on making investments that perform well in the long term. By succeeding on both of these fronts, we can form a self-sustaining cycle. The active managers who prove themselves to have outstanding performance, a consistent investment style and distinctive characteristics will be more widely favored by both investors and fund companies.
However, there is still a long way to go in reforming fund investment advisory system, it is certainly not going to happen overnight. Statistics indicate that only about 6% of Chinese fund investors will receive professional guidance before purchasing funds, while in the United States, this figure stands at nearly 50%. This can be attributed to two reasons: the training of professional investment consultants, and the investors’ awareness of how paying for professional services can benefit their investments.
In addition to training professional consultants, it is vital that we take advantage of technology as a way of promoting the fund investment consulting business. In recent years, intelligent investment consulting has developed rapidly both in China and abroad. In June last year, Ant Financial Services Group and Vanguard Group jointly set up Xianfeng Linghang Tougu (Shanghai) Investment Consultancy Company, 49% of which is owned by Vanguard and 51% by Ant Financial. In April this year, the “Help You Invest” service was launched by Alipay, and has already attracted 350,000 followers.
Compared with the existing investment advisory services in China, “Help You Invest” relies on Vanguard Group’s professional investment capabilities and Ant Financial’s strong background in Internet services to form such features as “fast judgement,” “low rate” and “low threshold” investments. When users open the mini program, with one click the system can make a judgement for on their “risk appetite,” such as “dynamic attack,” corresponding to an annualized investment objective of 9%. Then, the program matches fund portfolios, 70% for equity funds, 28% for bond funds and 2% for money market funds. According to our understanding, the judgement is based on user’s consumption behavior and financial habits on Alipay. The minimum required investment is RMB 800, far lower than the high threshold for such services in foreign countries. The user will be charged a 0.5% annual fee on assets under management, which reflects the move towards inclusive financing.
However, the accuracy of the one-minute judgement is questionable for investors who are new to Ant Financial, or for investors who manage assets across multiple platforms. In addition, the equity funds in the portfolio only cover index funds (mainly broad-based indexes; sector-based indexes are not yet supported), which is not sufficiently matched with the structured investment opportunities of China’s capital market in recent years.
Huang Hao, president of digital finance at Ant Financial, introduced that the company launched a small survey on Alipay about customers’ financial management methods. So far, more than 80,000 people have participated in the survey. 84% of recipients said they wanted to manage their money on their own, and only 16% said they were looking for someone to manage their money for them. Clearly, there is still a long way to go for the development of fund investment consulting services.
Opening up Financial market
“Bringing in” and “going global” are the two pathways for opening up the financial market.
In order to provide investors with more diversified asset allocation, domestic Chinese investment institutions can “go global” through QDIIs (Qualified Domestic Institutional Investors) or Hong Kong’s Stock Connect to invest in overseas assets. At present, 158 domestic institutions are qualified for QDII, at a total figure of USD 103.9 billion. Among them, there are 44 publicly offered fund companies with a QDII quota of USD 36.1 billion. As of this June, there are still 296 QDII funds remaining, with a total of USD 26.1 billion. However, many QDII funds are mainly allocated to overseas China concept stocks, owing to limited understanding of overseas markets.
Over the past ten years, foreign capital has held an increasing sway in A-shares, which is closely linked to the policy support designed to bring in foreign investment. The proportion of overseas investors holding A-shares rose from 0.3% in 2010 to 3.1% in 2020 (Q1), making this the fastest growing category of investors. The inflow of foreign capital is mainly passing through two channels: QFII/RQFII (RMB Qualified Foreign Institutional Investor) and the Stock Connect (including the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect). By 2020 (Q1), the total scale of these two channels has reached RMB 1.7 trillion, and they are constantly proving themselves as a force to be reckoned with in the Chinese capital market.
In July 2019, the Financial Stability and Development Committee under the State Council released 11 measures to further open up the financial sector to foreign participation, and announced that the deadline for removing foreign shareholding restrictions in the securities, fund management and futures sectors has been brought forward by a year to 2020. Since April 1 of this year, foreign institutions have been allowed to set up wholly foreign-owned subsidiaries in China.
2019 年 9 月 10 日，外管局宣布全面取消合格境外投资者（QFII）和人民币合格境外机构投资者（RQFII）的投资额度限制。2020年5月7日，相关政策进一步细化和落地，金融开放步伐向前，境外投资者参与境内金融市场的便利性大幅提升，外资流入将是长期趋势。作为A股市场重要的增量资金，外资的边际影响逐渐增强，将促进A股走向成熟的机构化市场。
On September 10, 2019, SAFE (State Administration of Foreign Exchange) announced that it would completely abolish restrictions on the investment quotas for QFII and RQFII. On May 7, 2020, the related policies will be refined further and fully implemented. With the pace at which financial opening up moving forward, the convenience for overseas investors to participate in Chinese financial markets will be greatly improved, meaning that there will be a substantial long-term inflow of foreign capital. As an important incremental capital in the A-share market, the marginal influence of foreign capital is gradually increasing, helping to turn the A-share market into a mature, institutional market.
Will this foreign competition pose a threat to our local players? The core competencies of overseas institutions mainly consist of sound institutional processes, systematic investment and research standards, rigorous risk control frameworks and an international mindset, especially in the pricing of derivatives and trading capabilities. However, domestic public fund managers may be more familiar with the domestic economic environment, the regulation systems in place, local market characteristics and Chinese investor behavior. Furthermore, Chinese publicly offered fund managers have more advantages in managing underlying assets such as stocks and bonds.
Indeed, China’s fund management industry has been greatly increasing its degree of openness. At present, Chinese-foreign joint venture fund companies account for more than one third of the total fund companies. The fund management industry originated from the West, and China, as a latecomer, has gone great lengths to study and learn from the industry. After the industry’s 22 years of development in China, a group of fund companies have emerged that are large in size, highly capable, well branded, produce excellent results, have a wide range of products and diverse channels at their disposal.
Whether a fund manager is “Chinese” or “foreign,” their aim always lies in “creating value for the holders.” As far as we are concerned, there are five key points in building the core competencies of asset management companies:
1) Investment and research capability, which is the core issue in ensuring the continuous growth of asset management companies.
2) Strategic choices, as in, how does the company position itself? Index investment or active investment? Equity investment or fixed income investment?
3) Management ability, which can be represented by human resources management.
4) Product design capability. In China, marketing is also important.
5) Brand influence. Brands need to be built to last for a long time, not to be a one-fix solution.
Looking back over more than a decade of the Rosefinch team’s development, here are some of our thoughts:
1) In terms of investment and research capabilities, the Rosefinch Fund focuses on industrial chain research and strives to, within its capabilities, become a major shareholder of a core company in a certain field. We should situate ourselves at the highest point of an industry in order to properly think about how it may be transformed, and the potential changes and risks in the future. Instead of taking short-term opportunities, we pay more attention to a company’s development over the next 5-10 years.
2) Our strategic choice has been to shift from private fund to public fund. More than 10 years ago, private fund industry underwent rapid development. When the Rosefinch team started business, the total AUM (Asset Under Management) of private fund industry was over RMB 20 billion, reaching more than RMB 10 trillion in 2015. Private fund managers also increased from just dozens to 20,000, which inevitably made supervision incredibly difficult. It was in this context that we applied for public fund license. Stricter supervision means stronger trust endorsement; meanwhile, we could enjoy policy dividends.
3) As for team management, we are not looking to train erudite talents like Wang Chongyang (one of the founders of the Quanzhen School of Daoism), but focus on training our own elite team, like the Seven Masters of Quanzhen (Wang Chongyang’s legendary disciples). In view of this, we have done two things. One is to reshape our partnership mechanism, creating exceptional teams by granting shares to key members. The other is digital construction, as our industrial chain research is closely related to digital upgrading.
4) With regard to reinforcing the liability side of the balance sheet, we have made it imperative to achieve long-term matching between liabilities and assets. We should strive to deepen our pockets, so to speak, and create a sound capital structure. In the Rosefinch Fund’s current management scale, institutional clients account for more than 60%, within which industrial clients constitute more than 60%. In other words, 40% of our funds come from industrial capital. This enables us to better practice industrial chain research and long-term investment.
With the transformation and upgrading of China’s economy and the continuous improvement of the basic systems in the capital market, China’s asset management industry has massive prospects for development. The development of professional institutional investors, including overseas investors, has intensified competition in the industry. Rosefinch Fund will adhere to active management of equity assets as our core strategy, continuously building our capability circle and focusing on industrial chains such as Advanced Manufacturing, TMT (Technology, Media, Telecom), Big Consumption, Healthcare. Together, this is designed to achieve our vision of constantly creating value for investors. We are striving to become a platform for overseas Chinese and institutional investors to share the continuous growth of Chinese enterprises and go global, together.
Investment Company Fact Book 2020
1. HWABAO Securities. 2020 China Financial Product Annual Report: A new era of wealth management.
2. CITIC Securities. Overview of A-share investors structure.
3. Investment Company Fact Book 2020.
4. Shenwan Hongyuan Securities. Trace to the American fund management industry:the four-aspect cycle of perfect pension system, institutionalized market, long term bull market indicated by the stock market index , passive investment and prosperity.
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