The China Securities Regulatory Commission (CSRC) issued a total of 17 licenses to asset management firms to engage in discretionary account investment (DAI) in February. These quasi-private equity products, thanks to their close-ended nature, are seen as a boost to revive the choppy domestic market, as some accuse mutual funds the prime suspect of causing sudden capital outflow in the A-share market during times of market downturn for their collective liquidation.
This new investment are only made available to high net worth clients with a minimum of 50 million renminbi (US$6.94 million) and it can invest in a range of financial products mutual funds are not allowed to tap, such as exchange traded funds (ETFs), derivatives and asset-backed securities (ABS). The performance fee a fund manager can charge is regulated at a ceiling of 20% of the investment gains.
To many fund managers’ surprise, many queries made to the company come from wealthy individuals, rather than of solely from institutional investors. Most of these individuals are owners of private company; for instance, Shenzhen based Penghua Fund Management Company says many entrepreneurs around Pearl River Delta have called to express interest to seek DAI.
In order to obtain the new license, the asset management companies have to demonstrate strong investment track record. Not only that they have to have a registered capital of 150 million renminbi and a net asset of 200 million renminbi, their open-ended fund under management has to remain at a minimum of 15 billion renminbi during the last quarter.
Traditionally, similar investment is done in the form of private equity, so many see this new business of asset management firms as stepping into the realm of private equity. However, fund managers may not agree. Jeremy Chen, head of discretionary account investment at Universal China Asset Management, says the two sectors have different investment philosophies and strategies as they face different client segments. As contrary to many may think, DAI will likely to adopt a riskier approach.
Chen explains that in the past, companies only conduct simple survey with customers before advising on their investment, be it on mutual funds or private equities. Hence, due to a lack of analysis and categorization, the investment advice tends to be more risk adverse and capital preserved. However, with a more detailed risk assessment system implemented with DAI now, the investment can be more aggressive according to client’s risk tolerance. As a result, he remarks, the introduction of DIA will also take China fund market a leap into building a more sophisticated risk assessment system.
Compared to private equities, asset management companies have more strength in terms of research and back office support because the DAI shares many resources with other teams in the company. Besides using a common research platform with the mutual funds, DAI also benefits from cross-selling. Wu Haoling, director of Asset Management Department at Penghua, says that many of her mutual fund customers have showed interest in DAI.
At the same time of research and customer sharing, nevertheless, it is important not to allow transfer of benefits between departments. Guidelines on “firewall” between departments to enhance independent investment decision making have been issued both from regulator and companies themselves. Wu points out that their research team, investment managers/fund managers and chief investment officer all work and make decisions independently.
Every coin has two sides. As asset management companies are highly regulated in areas of workflow, system and information exchange, their operation is not as flexible as those in private equities. As well, their investment instruments allowed to use are with less variety.
However, Wu suggests that competition between the two institutions is unnecessary because the pie is simply too big. According to Wu, China fund market has grown tremendously since Beijing issued the first asset management license in 1998. Now there are over 60 companies in the country, the size of mutual fund at the end of 2007 reaches 3.27 trillion renminbi, which is four times the size of 800 billion renminbi from one year before.
The size of the DAI market, on the other hand, Chen estimates it to be around 300 billion renminbi in the short run, with reference to markets in the US and Europe, which translates into around 10% of the total value of mutual funds in China.
Due to the market boom in the A-share market during the last few years, mainland investors incline to take profit from short-term investment. But now, this culture is yet to change. Companies begin to stress much more on mid to long term investment. Wu says, “We usually arrange investment of two to three years; some customers have asked for only a few months, but we require a minimum of one year.” Investor education is also important for DAI, she says there are private companies those want to invest all their cash into funds, “so we advise them not to”.
When asked what investment advice she has for clients, she says, short term investment customers are recommended to engage in risk arbitrage, and more sophisticated customers are opted to invest in equities. Though derivative investment is allowed, Wu suggest that it is mainly to satisfy hedging need at this stage, instead of making profit.
China Asset Management is also doing the same. “Just like other emerging markets, A-share market is very volatile; the share prices surge and plunge very quickly, so it is hard to record an outstanding performance within a three to six month period. We have spent much time educating customers on long-term investment so I think they start to understand our investment philosophy.” Chen says. The company holds different seminars for their clients, particularly during time of market volatility. “I think the customers are being more sophisticated,” he suggests.
