April 2008

ASIA FOCUS: Dog days in China

The world’s largest retail centre is, of course, increasingly attractive to asset management firms. But they need to tread carefully, warns Fiona Rintoul, as China is a very complex market ... “It’s better to be a dog in a peaceful time than to be a man in a chaotic period,” runs an old Chinese proverb. With riots in Tibet, Steven Spielberg, the Hollywood producer, quitting his Olympic role, and jitters on the stock market, you could be forgiven for thinking some of China’s leaders might right now be dreaming of a quiet kennel in the country. And so might the many international asset management firms that have entered the Chinese market to sniff out the huge potential supposedly afforded by the world’s largest retail market.

Dog Pic It’s easy to understand the draw of the Chinese asset management market. “Of all the financial services opportunities in China, none is more tantalising than asset management,” wrote Stephan Binder, Joseph Luc Ngai and Yi Wang in an October 2007 report from McKinsey & Co entitled The Opportunity in Asset Management in China. “Fuelled by the investment, retirement and insurance needs of increasingly affluent Chinese consumers, the sector has grown at a rate of more than 60% annually for the past three years.”

McKinsey & Co estimates that assets under management in China will rise by 24% annually for the next decade. This would mean not only that China’s asset management industry would expand more quickly than those of Europe or the US, but also that asset management would be the fastest-growing segment of financial services within China.

Challenging times
But then there’s the worrying backdrop to this enchanting picture of growth and advancement. Marrying a Communist government with a free market economy was always going to be a challenge. In his 2007 book The Writing on the Wall: China and the West in the 21st Century, Will Hutton outlines the scale of the endeavour. “It [China] is a sophisticated civilisation beset by profound and deepening problems that is making a difficult transition from a primitive and poor peasant society to modernity,” he writes.

Hutton’s aim is not to condemn China or belittle its efforts, but to convince those in the West threatened by the prospect of a ‘Chinese century’ that their fears are unfounded. “China requires our understanding and engagement – not our enmity and suspicion, which could culminate in self-defeatingly creating the very crisis we fear,” he writes.

It’s tempting to see the current difficulties in China as a sign that it’s all starting to unravel. Hutton suggests that in order to succeed China will have to embrace “the enlightenment values and institutions that propelled the West past China in the 19th century”. Recent authoritarian pronouncements ring shrilly in Western ears and suggest that a warm embrace for Enlightenment values is some way off.

And yet, in many ways, commentators are more optimistic about China than they have ever been. For example, Robert Lawrence Kuhn, a senior adviser at Citigroup and co-editor-in-chief of China’s Banking and Financial Markets: The Internal Research Report of the Chinese Government, praises the governmental stability that China has now managed to create.

“I’m impressed with the next generation of leaders,” Kuhn says. “And if you look at stability, there is stability now for the next 15 years without uncertainty and with sufficient collective control so that no-one can become a dictator.”

There has been a diminution of singularity of power with each generation, says Kuhn, and “China is really reaching out and figuring out new ways of involving people in participatory government”. In many ways, he suggests, the “well-trained, well-seasoned” new leaders in China compare favourably with the situation in the US where there are three candidates and it’s all very entertaining but the eventual winner may “still not be up to the world-class standard of a national leader”.

Opening market
These things are important, for if the many international groups already present in China, and the many more who are no doubt thinking about entering, are to have any chance of building a decent business in the country, openness at the governmental level is an absolute prerequisite.

A strong sign of increasing openness was given last year when QDII (qualified domestic institutional investor) funds were introduced. These are Chinese funds that can invest in foreign markets.

“This was a very important step in the opening of the Chinese market,” says Denis Lefranc, deputy general manager of Fortune SGAM Fund Management, whose firm is one of ten companies that have so far been awarded a QDII licence.
Unfortunately, the timing of the introduction of the new funds was somewhat catastrophic. Fortune SGAM didn’t launch its fund until the end of March, but some funds were introduced at the end of 2007.

“This means that unfortunately the Chinese customer’s first contact with foreign stock markets has not been very positive,” says Lefranc. Although the Chinese market fell too, the effect was less dramatic than with QDII funds, which were also affected by the degeneration of the US dollar. “Some QDII lost 30% of their NAV,” says Lefranc. “You don’t have such a depreciation for domestic funds.”

With Chinese investors very focused on short-term performance and happy to churn their portfolios over frequently, the immediate outlook for QDII is a little dismal. But that doesn’t change the fact that the funds’ introduction was a positive development.

“We are pleased with this licence,” says Lefranc. “The QDII market can boom again if the funds have better performance. Maybe by the end of 2008 this will be the case.”

In February, there was already some improvement. “QDII funds recovered some ground, increasing 3.32%,” notes Lipper in its monthly China Fund Market Summary. “They showed their function of diversification.”

Economic resilience
Meanwhile, the comparative robustness of the Chinese economy is a reason to be cheerful for anyone involved in the Chinese market. The conventional wisdom that China is tied to the US and if the US hurts China will hurt has been challenged.

“The Chinese markets in general are doing well compared with the rest of the world,” says Kuhn. “China is less vulnerable to exogenous economic factors than people once thought. The economy seems more resilient than people realised.”

Combined with political stability and openness, this economic resilience should lead to more opportunities for asset managers wanting a slice of China. Already, the well-trodden path into the market of establishing a joint-venture asset management company with a local firm is starting to look a bit overgrown with brambles. That’s because there are fewer interesting companies to partner with, the interesting ones having already been approached, and Chinese legislation does not currently permit firms to go it alone.

French group Crédit Agricole recently announced a joint venture with the Agricultural Bank of China, one of the four big banks in China and a key player in distribution. But in general, Lefranc says, the CSRC (Chinese Securities Regulatory Commission) is increasingly pushing foreigners to take a stake in existing fund management companies. This means the valuation is not the same and the entrance price is higher.

“Everything depends on the percentage you can have, what kind of people they have in the company, whether you keep the same management,” says Lefranc. “It’s more complicated, but still attractive. Before the only possibility was to launch mutual funds, now you can launch QDII as well.”

Increased opportunities
There are further new opportunities as well. Fortune SGAM has just received a licence to offer segregated accounts, which means it can target institutional investors, such as the increasing number of pension funds in the market. “Now fund management companies can also get a pension fund licence,” says Lefranc. “There is more business open to fund managers, more opportunities.”

For the time being, accessing this expanded range of opportunities involves partnering with a local firm in some shape or form. The choice of partner is crucial as partnering with the wrong people can be disastrous. And it’s a choice, suggests Kuhn, that isn’t just about business acumen, but also about where your potential partner stands in the political pecking order.

“As long as the ruling party retains an absolute monopoly on power, political relationships will remain important,” says Kuhn. “Even if that changed, culturally relationships are personal rather than purely legal. You don’t find any desire to really change that in China.”

This means that when choosing a partner, foreign asset management firms need to consider factors they perhaps wouldn’t consider at home. One could be the age of the potential partner. Building a relationship with a partner who is close to retirement can be a mistake. It’s better to go for someone in a lower position who is younger. “Power in China is more related to your next job than your current job,” says Kuhn.

It’s also worth remembering the strength of the local competition. Of the top ten fund management firms in China, just one (Invesco Great Wall) is a joint venture with one other foreign-invested (see chart, below). 34_chin_table.jpg Local competition
“Foreign investors should not underestimate their local competition,” warns business consulting firm PwC in its November 2006 report Entering the Chinese Investment Management Industry. “Although the local players may not have the expertise of their international counterparts, a combination of established relationships and cultural and linguistic understanding has given them a valuable head start.”

Increasingly, local companies also have a head start in distribution as the big four banks have moved to set up their own fund management companies. But the four big distributing banks all still sell independent managers. Fortune SGAM has even started to sell its funds through three of the big banks, though this is unusual.

“Generally speaking companies stick with one bank,” says Lefranc, “but so far we have succeeded in managing the different sensibilities of these banks.”

The bottom line is that China is a complex market that requires a deep understanding of cultural issues and a willingness to work within the present contingency, even if you have one eye on a rosy future. But the signs are that those willing to make a commitment to the market will be repaid.

“There is a gradual continuation of liberalisation,” says Kuhn. “There are certain things that are coming up for approval. There should be increasing opportunities for foreigners, primarily in partnership with Chinese entities, but perhaps eventually on their own.”

Interesting times in China, it seems – in a good way.

© funds europe 2008

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