Asian investors are digitally savvy, especially in China, which leads the world in financial technology. Yet regional markets remain fragmented and progress on passporting schemes is slow. Chaired by George Mitton in Hong Kong.
Stewart Aldcroft (managing director and senior adviser, Citi Markets and Securities Services)
Patrick Corfe (marketing director, Aberdeen Asset Management)
Andrew Gordon (managing director, Asia, RBC Investor & Treasury Services)
Karine Hirn (partner, East Capital)
Showbhik Kalra (head of intermediary and product, Asia-Pacific, Schroders)
Funds Europe: Risk factors affecting business decisions are extensive – from Chinese growth, to rate rises and the ending of stimulus measures, to Russia and the Middle East. Which are having the most impact on your business?
Patrick Corfe, Aberdeen Asset Management: The politics is a guessing game, I would say there’s no point dwelling on it. The effect of quantitative easing on products, fees and margins has been a more immediate constraint on business. We are having to work harder to earn a return. The movement from benchmark-driven returns to outcome-oriented returns has changed the focus on asset classes within the industry. Rightly or wrongly, Asia is still defined as a growth area in a global context. The question, though, is where this growth going to come from, given our collective expectations have run ahead of buyer caution.
Karine Hirn, East Capital: As a company dedicated to emerging and frontier markets, it’s interesting that all of the questions put here as potential risk factors are, for us, upside risks. The potential for China’s growth to slow is not an issue for us because we invest in sectors in China such as environmental protection, which is booming and outperforming the rest of the market.
Regarding politics, we have a lot of investments in Russia, and the political developments today in the US are actually very supportive to Russia for a number of reasons.
The biggest risk to our business is what I’ll call the tsunami of passive investments in our industry, including in emerging markets. It has an impact on our ability to create value because we are active asset managers and when you have a herd of people joining the indices, it can be painful.
Andrew Gordon, RBC Investor & Treasury Services: The main questions for us, as a fund servicer, are around changing investor sentiment and what that does to the behaviour of the investors.
There are reasons to be optimistic. There are still a lot of middle-class people in multiple countries around the region who are earning more than they need for their basic wants. They’re buying insurance policies, they’re putting money in the bank. Some of them are buying mutual funds. We’d all like them to be buying a few more of those but the demographics, the macroeconomics, the growth that we’re seeing across the region ought to be attractive.
Stewart Aldcroft, Citi Markets and Securities Services: One of the concerns I have is that many developed markets are heading to new heights. For the first time since 1999, all four major indices in the US hit new highs in November and what happened soon after 1999?
Equity markets have produced a return better than you could have got out of deposits, inflation or fixed income this year. They have done very well for those people that stayed in them, but many people didn’t. The industry has failed in its message-giving to investors, in my view.
In terms of Chinese growth, remember that China is the world’s expert in managing their economy and whether you believe the numbers or not, they’re still doing OK.
However, there is one risk factor I would highlight, which is overestimating the pace of change. Regional passporting in Asia has been a massive disappointment for everybody who’s had anything to do with it. It’s not only that it should have been better handled, it’s just been so slow.
Showbhik Kalra, Schroders: Political uncertainty and the continued rise of populism in Europe are one of our biggest concerns. Of the three major elections in the eurozone in 2017, the French presidential vote has the greatest potential to produce a shock. Front National leader Marine Le Pen is expected to lose in a run-off, but given the recent dire performance of the opinion polls, we should not rule out another surprise. If elected, she would call a referendum on France’s membership of the EU, creating the potential for a ‘Frexit’, the loss of a cornerstone of the EU and ultimately the break-up of the euro. Another of our concerns is around ‘Trump the protectionist’ triggering a trade war. While we do not think Trump will follow through on his threats to put high tariffs on imports from China and Mexico and tear up the North American Free Trade Agreement, there is a clear risk that the new president-elect feels obliged to follow through on campaign promises.
Funds Europe: Is regulation or broader pressure from clients affecting the distribution landscape in Asia? If so, how, and how are asset managers changing as a result?
Corfe: Regulation is an integral part of doing business, you just have to accept it. Has it got more onerous? Yes. Just look at KYC, AML [know your client, anti-money laundering]. There’s increasing scrutiny, which is being driven post-crisis by a concern for the consumer, understandable though that is.
Another problem is that, in Asia, there are more competitors than there were. We have had to reconfigure some of our product offerings. There’s been some soul-searching. However, fundamentally, from a margin point of view, asset management is still an attractive business to be in.
That said, getting funds on to distributor platforms has become harder. Most distributors have restricted access by widening their criteria for inclusion, not just talking about performance returns but also servicing and brand support. Certain channels like private banks have more or less said that they only want products that can’t be found among ‘supermarket’ distributors. They’re looking, for example, at co-managed products to justify their existence. All this complicates things because if you have to come up with products on a bespoke basis, that changes the model.
Aldcroft: The problem for fund distributors is that there are far too many product providers and in many cases their servicing is poor. Access to those that make the fund management decisions is being restricted and ultimately the performance has been relatively shabby. If you’re a consumer/retail bank or a private bank, you’re there to be the trusted adviser to your customer. You’re not there to be the sales person for the fund company.
As we’ve already described, the active management space is underperforming against benchmarks. The alternatives are ETFs and index funds, which don’t pay distributors. If you’re a distributor or an adviser to a client, you’ve got to be looking for things that are not underperforming or that are giving something different, and when everybody comes along with a me-too product, that’s not helping.
Hirn: If you compare Europe and Asia, Europe has already gone far ahead in terms of regulation. The regulations related to remuneration of risk-takers, for example, becomes an issue for talent. All the regulations related to retrocessions become an issue for independent asset managers. It makes it more and more complicated for us to manage our channels. We want to remain a producer but we are forced to think in terms of being a distributor because our distribution channels are being challenged.
Most probably Asia will follow Europe. There is some hope related to technology whereby we as an industry could comply with all these requirements in a smoother way. Ten years ago, ‘regtech’ didn’t exist. Now maybe in Asia there will be solutions.
Gordon: Fund managers also have to deal with the realities of fragmentation in Asia. If you want to make your strategies available to investors in multiple Asian markets, what do you do? Ucits still remain an attractive solution for markets such as Hong Kong and Singapore, Taiwan is still attractive, but it’s becoming harder to get new Ucits registered there. In Indonesia, you need a local fund.
As you look around the region, the way the regulations are set up, it makes it difficult for an asset manager to have a simple, clean operating model in the fragmented markets, which also bring operational risk and expense and requires managers to submit to some very different types of regulation, and that’s before you start to think about the potential arrival of RDR [the retail distribution review] or an equivalent in Asia.
Kalra: In Asia, we do not expect a great change in distribution landscape over the next couple of years. Investors want to receive good, suitable and timely advice. We believe the large, well-established distributors with their resources, reach and expertise remain in the best position to deliver on this.
We do not see this significantly changing in the near future. Clients in many parts of the world are facing similar issues, and we see increasing demand for outcome-oriented solutions that take advantage of a global opportunity set. On balance, this is likely to favour Ucits funds.
Funds Europe: How has the funds landscape in Asia been affected by technology and digital trends?
Corfe: Tech is the theme du jour. On the client-facing side, it’s a bit of a fantasy at the moment to think that somehow, when you talk of robo developments, that’s going to disintermediate or change the way funds are distributed. Fundamentally owning the client is, given regulation, a costly business and tech won’t automatically make that easier. What it will make easier is the ability to give recommendations to a certain category of clients, namely those who can’t pay for full advice.
If you see how it’s been adopted in the West, it’s very much through a conjunction of drivers, such as defined contribution pension schemes, the RDR and regulation in the UK around ending annuities. A whole group of pension investors are becoming self-directed and that demand, along with technology, such as on a low-cost platform, is very potent. In Asia, where the demographics are different, it’s perhaps less spontaneous. The adviser communities tend to be smaller. I think the adoption will be among a progressive minority of distributors. Having said that, you’ve seen in Taiwan that the government has co-sponsored an online platform. It could be a Trojan horse.
Gordon: In terms of technology, China is different. It has had some explosive growth, at least for the Tianhong money market fund. It remains to be seen whether they can use a similar approach to distribute passive funds and ultimately active funds. What is interesting is how supposedly younger people who don’t have excess cash to invest or to save have invested through Tianhong.
Hirn: Yes, but it’s only a money market fund. It’s there to collect the couple of renminbi you have left on your Alipay account after your Taobao transaction and instead of just having it lying there, you put it into something that is called a fund. The fund became huge because of the size of the Taobao user base but it’s very short term.
Aldcroft: To take the Yu’e Bao fund example, they’ve raised over $120 billion. They have three million investors, all in less than two years. They’ve got a system that works but their problem is that they haven’t yet found a way to repeat that. As we know in the fund industry, you need to have a repeatable process.
Asia, with the exception of China, is nowhere near being advanced in terms of technology. The regulators still provide a far too conservative approach to it. In Hong Kong, for example, you can’t have robo-advice and you can’t have online fund selling of mutual funds. When I first came here, and for the first ten or 15 years, fund companies could sell direct to the public. These days, they can’t.
In China, it’s quite the opposite. Everything can happen. Distributors are pretty active. There are many different platforms being created with varying degrees of success. Not a lot of success yet, but they’re doing it.
Gordon: On the operational side, there are some interesting developments. You may be shocked by the sorts of institutions from Hong Kong and Singapore that still send us fund orders by faxes. Progress is being made. Taiwan, four years ago, was largely fax, now it’s 80% or so STP [straight-through processing], which benefits the manager, the distributor and gets faster information through to the end investors.
Hirn: We have to remember that Asian middle-class people are very tech-savvy. Indonesia has the highest penetration of Facebook. In China, a majority of online purchases are done on a mobile phone. Of course, these people will want to buy funds online. If they buy everything else online, why would they suddenly think it’s OK to have to send a fax to a fund management house or come to an office?
Kalra: Technology is an opportunity for us across multiple fronts. We have made significant strides, and continue to invest in using technology as a distribution business to not only be more efficient, but also more relevant and timely, when it comes to interacting with and servicing our clients.
Funds Europe: Is the asset management industry in Asia too crowded? Have there been significant signs of M&A?
Aldcroft: In terms of M&A, has there been activity? Not at all, but in the last couple of months, I’ve talked to maybe six mainland firms who are all looking to find some way to get into fund management, for instance by buying a business.
However, I’m questioning them as to whether they should build a wealth management business instead. The opportunities in China are evidently far more appealing in the ability to distribute product than they are in the manufacturing of product.
Gordon: There’s also interest from the Western asset managers to come in because not everyone is as well established in Asia as Aberdeen and so on. They read the headlines, they jump on a plane, they come over, they realise that there’s complexity but they want scale because otherwise, to be honest, it’s irrelevant.
The reality is that there aren’t many Asian asset management businesses that have scale, apart from some of the domestic firms in China, that might be available for someone to buy.
Hirn: I’m interested in looking at Chinese asset managers going abroad and buying assets, not only in Asia but in other places. I’m sure we will be surprised in five years’ time to see the number of deals that have been made and might have failed as well. It’s not easy.
One of the reasons there are very few M&As is because this is a human capital-intensive industry where changing the owner could mean destroying the culture, causing people to leave, and then you’ve got something that’s worth nothing.
Funds Europe: The Chinese asset management market has continued to open up with wholly foreign-owned enterprises (WFOEs), the Mutual Recognition of Funds (MRF) scheme and Stock Connect. Are the impacts of these advances being felt?
Hirn: We are not part of the mutual recognition of funds scheme but it’s interesting and important for Hong Kong in terms of being a relevant and growing international financial centre and a gateway to China. However, flows have been concentrated and really only one fund management house has done well.
The Shenzhen-Hong Kong Stock Connect is important for us. We already had access to Shenzhen through a QFII quota and P notes, however it paves the way for A-share inclusion in the MSCI indices and opens up a market which is much more exciting than Shanghai. About 75% of Shenzhen issuers are not state-owned. There are many higher growth companies, and it is an extremely liquid market.
Aldcroft: On some measures, valuations in Shenzhen seem high. The market has average valuations 25 times earnings. But when you factor in the growth multiples that they’re talking about, it’s relatively inexpensive, even on a Western basis.
Hirn: With Shenzhen Connect, a number of stocks in Hong Kong that were not formerly included are now added and accessible by mainland investors. They happen to be the kind of stocks that these mainland investors like in terms of growth profile. It is a major development on the local market that will have implications.
Gordon: If you stand back and look over a number of years, there’s been massive opening up in China. Whether the timing is good or bad or whether it takes off slowly or quickly, there are many initiatives that have been launched. They evolve, some of them work and grow to be very big. RQFII has done very well. Stock Connect has done all right so far. Stock Connect is still slow with some of the regulated funds as they get used to the structures, but the Chinese market is much more open and that has a positive impact on most participants.
Aldcroft: The worry I have on the mutual recognition scheme is that it’s developing so slowly. Only six funds are allowed to go northbound, while 45 or 47, depending on the counting, are allowed to go southbound. There’s clearly a deliberate action on the part of the mainland to prevent more Hong Kong funds being given that access.
There appears to be no effort being made by the SFC to support the Hong Kong industry in getting more funds to go northbound and of the ones that have gone, only one of them, the JP Morgan Asian Total Return Fund, has done well. It’s raised over $1 billion.
Now we’re at the same point, possibly, that QDII was in, where the market’s turning and all of a sudden we haven’t got the choice of products in the market. Those that have been bought are going to be disappointed because the top has clearly come in fixed income high yield.
The fact is that in Asia, the whole passporting system has not done what was expected of it by any stretch of the imagination. The masters in Luxembourg and Dublin are rubbing their hands and saying, thank goodness for that.
Kalra: China presents a very compelling long-term opportunity, both in terms of reaching new clients and from an investment perspective. The Shenzhen-Hong Kong Connect will provide overseas investors with an opportunity to buy ‘new China’ stocks. We are seeing a crackdown on the property market both through macro-prudential measures and, reportedly, the credit channels as the central bank leans on lenders. As housing cools, the strong returns enjoyed in the years prior could be ploughed into the equity market. The confluence of these factors accompanied by the current positive liquidity environment could be quite supportive for the Chinese equity market.
Funds Europe: Which Asian markets offer the greatest opportunities in the next few years for global investors?
Corfe: There’s no question about the potential of China due to its size and its potential to improve itself. I say that because the quality of companies is generally so poor that we think they can only get better. Frankly, though, India is a more interesting place to invest. Foreign ownership is very low and it’s a diversification story that tends to be less correlated with other markets.
Ultimately a lot of the companies in China are politically controlled. The state-owned enterprises are run by whom? The non-execs are who? The reason we set up an A-share fund a good few years after the competition is because of that scepticism.
Hirn: We like frontier markets. The story is a good one. On the macro side, it’s good in terms of earnings growth of these companies. It is also very good as a long-term story for reforms that open up the markets. Vietnam is a good point here, Pakistan will be upgraded to emerging markets next year. The political situation is more stable.
Some of these markets are still not very sophisticated, and usually have lower liquidity. They are not appropriate for passive investments and in that sense, these are better markets for us to create value because we are less disrupted by passive funds.
Frontier markets have been lagging behind emerging markets this year. The level of visibility is low given the implications of Trump’s presidency, but if things calm down and stabilise, the frontiers will have a good run next year.
Aldcroft: Markets are topping out in the Western world but in the emerging markets, they’re not. When we see places like Thailand that seem to be transitioning from the death of the king to a new king far more peaceably than many had predicted, that presents an interesting opportunity.
Generally, these markets have potential in them. However, it’s difficult to guess the future. Who would have predicted the US markets would hit a new peak after they elected a showman instead of a politician as their next president?
Kalra: The ‘protectionist Trump’ shadow does loom over emerging markets, and we have seen significant outflows from emerging markets in the weeks following the US election. Once the dust settles, we do think the prospect of higher yields in emerging market fixed income and more attractive valuations in emerging market equities, relative to developed markets, will prevail. Hard currency-denominated emerging market fixed income is likely to initially benefit as clients might be cautious on taking currency risk. Subsequently, we anticipate well-managed products that provide exposure across the emerging market spectrum of assets will see demand.
©2016 funds europe