China roundtable Dec 2015After a turbulent year for the Chinese stock market, Funds Europe’s panel of experts in Beijing discusses the economy, domestic retail funds, the high-net-worth sector, Stock Connect and the future of the renminbi. Chaired by Nick Fitzpatrick and Alan Chalmers. Participants:
Patrick Liu
(chief executive officer, HFT Investment Management), 
Andrew Smart (special assistant general manager, CCB Principal Asset Management)
Amy Wang (head of Greater China – institutional, Pioneer Investments)
Philip Cheng (head of international business and strategic partners, HSBC Jintrust Fund Management)
Tilman Fechter (head of investment fund services, sales and relationship management, Clearstream) Funds Europe: China’s economy is a key driver for global growth with near double-digit expansion rates. Given recent declines and continued worries over the economy, what is a realistic assessment for the outlook for China? Andrew Smart, CCB Principal: As China transforms from an export-driven economy to a consumption-driven economy, there’s going to be some variation in how the country is perceived by the market. There is a change taking place and how fast that takes place has opened up opinions. Amy Wang, Pioneer: Apart from the balance between investment and consumption, we hope to see that the share of the private sector’s contribution to GDP growth has increased. There are supportive policies from both the fiscal side and the monetary side, which should anchor GDP growth in the coming years.  You have to think about the absolute number of GDP growth. China is now the second-largest economy. Ten years ago we had a double-digit growth rate but the base, the foundation, was smaller. Growth of even 5% today is larger, in absolute terms, than when we had the double-digit growth rate ten years ago. Philip Cheng, HSBC Jintrust: We don’t need to worry about China’s economy. Annual economic growth of 6.5% is the bottom line for the government to meet its goal, according to China’s 13th Five-Year Plan. However, even if it further slides to 5%, it will still be superior to 8% growth in the old model, given the improvement in quality and sustainability. I suggest we focus more on the progress of economic reforms instead of the GDP numbers. Let’s see when and what real change will happen if the market will be given a decisive role in resource allocation. Patrick Liu, HFT: If you go around China, you will see some companies are facing challenges – cost of capital, accessing capital and so on. These are the structural problems that require change, and these issues are behind the falling growth rate. The country is working towards a new equilibrium and the government has been gradually steering the economy to reach this equilibrium. Tilman Fechter, Clearstream: The excitement in all of the macroeconomic parameters is still there, but what investors are now doing is trying to look behind the numbers, trying to be more diligent in their assessment and not get distracted. I am still optimistic despite the hiccups. There are great opportunities in the fund management space, because China is turning from a savings nation into an investing nation. Funds Europe: What is the cause of China’s recent stock market volatility? To what extent did retail investors play a role in it and also, what are China’s authorities doing to increase the participation of institutional investors in China’s retail-driven stock market? Might more institutional participation help reduce volatility? Smart: We saw some of the government programmes that were put in place to encourage investors to go into the market, but they went too far. Volatility was introduced into the market and people ended up on the wrong side of that. The market practices have now changed and the regulators made some of those changes. As an asset manager, you have to be nimble and respond to the market as it changes. It is part of our job to help change the behaviour of the retail investor. We want to provide education, we want to provide outcome-oriented solutions, but you’re pushing water uphill to try and do it all.  Liu: The volatility this time around was quite harsh but it was heavily linked to leverage. The deleveraging process was rather abrupt and this caused the recent market volatility. Investor education will continue to be important in the retail space. What could potentially change, alongside investor education, is by greater institutional investor participation in the market. The market is moving in that direction, though, with the development of occupational annuities, and the NSSF [National Social Security Fund] managing province-level pension funds. A lot of banks are starting to hire fund managers to manage their assets with an institutional approach. Fechter: A lot of investments which came into the stock markets from retail customers were leveraged. A lot of people didn’t just lose their money but some had potentially ruined themselves. The question now is, was it too much of a shock for private investors? Are they burned forever or are they going to come back to the markets as soon as the dust has settled and the outlook is positive again?  The investment fund industry’s challenge is that it sells long-term savings products – you don’t want hot money in and out. Funds are not a trading product and if you have an investor base which is short-term oriented, there’s a high probability they will de-invest very shortly. Liu: If you look deeper, the real issue for the asset management industry in China is moral hazard. For instance, you have all these competing products launched by the banks, by the trust companies, by the brokers, all explicitly or implicitly guaranteeing certain returns, especially over the past few years, as high as 10%-12%.  Wang: The way you describe it, for trust products and other products that are very similar, this was true in the past but now the regulators, in particular at the CBRC [China Banking Regulatory Commission], the banking regulator, are trying to ensure that none of these products are allowed to make a principal guarantee in terms of a certain rate of return. Some of the trust products have already gone into default and they’re unable to meet their interest payments and the principal is at risk. It has happened in the past. But with the regulators’ efforts, I’m optimistic that in the future we will not see this kind of guaranteed return product in the market. Liu: That’s why people around this table should be very hopeful. We have over 10 trillion, probably 20 trillion, within the banks under a suite of wealth management products because they are guaranteed. Once these don’t deliver, people will realise mutual funds are a more reasonable alternative and you will see a huge inflow coming into this space.  But coming back to the point you made, the regulator has always banned trust companies and banks from making such promises. The real expectation comes from the investors. If you have products that don’t deliver what they said they would, people will come to your bank to demand compensation.  Now, that is culture and that is unique to the country. To change that moral hazard caused by these guaranteed products is not an overnight story. It’s a cultural issue. Cheng: Investor education is very important. Investment carries risk. But many retail investors in China still have little idea about the risk-return trade-off. They tend to set high expectations on fund returns without appreciating how high the associated risk is. Funds Europe: How do you expect the domestic retail fund management market to grow? What products might the retail public want in future and how much appetite for international products do you think there will be? Liu: Two parameters decide the size or the behaviour of the industry. One is GDP and the other is the savings rate. Both the US and Japan have matured domestic asset management participants. China is growing towards the same direction. Within these markets, there is always significant allocation locally because of the sizeable domestic market. It can absorb probably 70%-80% of one’s portfolio with a reasonable level of diversification across different asset classes, and roughly 20%-25% will be allocated to the global market from experience. This is probably the level of international allocation in the US and Japan. Again, this can happen in China. Cheng: In the future, managed solutions will be best to meet investors’ needs, because managed solutions are a type of needs-based solution, and that can match an investor’s risk profile and manage their investments, long-term, through different market cycles, with active and flexible allocations. With this type of product, clients and investors can dedicate their entire portfolio to professional asset managers. Smart: You can go to banks and get a lot of these international strategies today within QDII [Qualified Domestic Institutional Investor] vehicles, but the popular ones tend to have more of a local bias, so Greater China is something they are much more receptive to as opposed to Latin America or a European fund, or something that’s going to get them quite a bit more diversification. Cheng: The other reason that we experienced the low penetration of international funds in China is the continuous appreciation of the renminbi against the economy. As the trend seems to have come to an end, the penetration of QDII balances will pick up. Wang: Another factor is that when QDII started in late 2007, a lot of funds raised huge amounts of money, but unfortunately the market crashed right away – about 50% down or even more than that. It significantly hurt investor sentiment and then investors didn’t want to touch QDII. Smart: One of the things that’s going to be challenging for international investors in this market is that the Chinese investor expects the portfolio manager to make market adjustments in their portfolios as the environment changes. They expect the manager to go outside the benchmark or to hold a bunch of cash or to do those sorts of significant changes that an institutional asset manager that works for a global firm is not going to do. If you meet the benchmark or you beat the benchmark, as a portfolio manager that’s a success, but a Chinese investor might say, “I’ve got this other benchmark that’s absolute return and you didn’t meet that, so I’m going to sell out of that fund.” Fechter: A high-net-worth individual who had seen a couple of things happening around the world would maybe go into diversification, with some conservative assets, and a bit of speculation. They would do it differently than the retail investor who is maybe more speculative. Ultimately, the investment fund industry also needs the institutional money – the pension funds and the sovereign wealth funds – because these ones are long-term oriented.  Funds Europe: How do you see the high-net-worth sector growing domestically in the coming years? How is competition developing between local private banks and international firms coming into the market? Do international firms have much brand recognition at this stage? Cheng: International banks not only sell products, but also provide an advisory and consultancy services to clients to help them preserve their wealth for future generations. They have been long enjoying strong recognition in China. But we are glad to see that their local counterparts are catching up fast. Fechter: The high-net-worth market is growing strongly, with predictions it will outperform what we have seen in the Americas. With mutual fund recognition and other players venturing in the market, competition is fierce. Companies from Hong Kong and, maybe, later, all of the other international ones, directly will come into China and they will compete. If new entrants want to sell their funds, they will probably try to target the high-net-worth individuals first, because those are the ones which don’t only compete or compare on the performance aspect but also want to diversify and get risk exposure in other markets. Do international firms have much brand recognition? No. They don’t and they realise they need a local partner, a local distributor bank or a local asset manager, who puts them in the same shelf using their distribution access. Funds Europe: How important are the Stock Connect initiatives in Shanghai and Shenzhen? How would you describe the success of the Shanghai-Hong Kong Stock Connect programme? Smart: We would say ‘happy birthday’ to Stock Connect. It is one year old and it’s reasonably successful. It’s got different uses for different investor bases. I read it’s about 40% utilised on both sides, so the north and the south are both similar, with perhaps a little more volumes on northbound trade. Fechter: It’s not in competition with the asset management market at the moment. The question, I think, is whether the passive instruments listed in Hong Kong could be in competition with those in mainland China. If they open up ETFs which are listed in Hong Kong, would they then automatically also make them available in China? That could be competition, because what we see on a worldwide scale is that ETFs are growing at the fastest speeds.  Liu: In Hong Kong, stock is being analysed with a more traditional and international standard which can be changed. I remain interested to see how valuations on the two exchanges will merge at some point: Chinese money on the Chinese issuers versus international money on the Chinese issuers.  How the two methodologies may evolve and eventually converge? Cheng: With Stock Connect, they moved down to between the onshore and the offshore Chinese equities. What’s most exciting to me is that it will give birth to the homogeneous China asset class. That’s very important for China. Liu: I agree with that. For the industry, for MSCI and all the market participants, this is good news because it will make Chinese equity an asset class, just like US equity or Japanese equity is an asset class.   Funds Europe: How do you see the mutual fund recognition initiative progressing and what is the timescale for full implementation? Smart: It has been slower than anticipated. A couple of funds have been reviewed and lodged but there’s no funds being sold on either side so far. Asset managers are working with their agents and there’s a lot of work to do because everything has got to be in dual language. There are types of information that you have to have available. There is some reconciliation that takes place between the different managers. But the regulatory components are essentially in place. Liu: Mutual fund recognition may steer the local asset management firms to focus more on enhancing product design and distribution. Smart: Certainly what we are seeing so far and, what we’re going to see more of, is funds being domiciled or re-domiciled in Hong Kong. The regulator is interested in having asset management teams on the ground. It’s not just having a couple of institutional sales people in Hong Kong. They want teams there managing money. It may not be an explosion, but you’ll see a bigger component there than what you see today. Fechter: They are planting the seeds now. They are all aware that there are no quick wins in two years’ time. But they are going to bump up their assets under management in Hong Kong if that helps them to attract more of the Chinese market. At the moment, the biggest problem they are having is they haven’t got the market access yet. They haven’t got the distribution channel. Mutual fund recognition has one downside: it doesn’t give the ability for product innovation. You can’t include any product which is, let’s say, really interesting – a leveraged hedge fund, for instance. You need to have long-only equity, bond or mixed funds but no leveraged products. Wang: Although there are limited opportunities at this moment, things will get interesting in the long run.  Funds Europe: How do you rate the progress of the China currency as it moves towards becoming a global trading currency? Is the status of the currency as a global trading currency of significance to the China asset management industry and why? Liu: I am thrilled to see the renminbi has been included in the SDR [special drawing rights] basket because more global institutional investors will come and say, ‘I want to build a fixed income portfolio with exposure into renminbi.’ This is an exciting time for us, even more so than mutual fund recognition. Smart: I see it the other way. I don’t think it’s a big deal. Very few people care about the SDR and I think that institutional investors in particular are going to focus more on the market interventions over the summer and the ineffective approach with the mutual fund market. That has more to do with investors’ perceptions of, not scalability, but the individual appreciation of the market itself. I mean, do you feel confident in your ability to invest in the market and not have the market make all these whipsawed moves on you? Wang: We have seen that in the local market in China, some institutional players want to have a renminbi-denominated share of mutual funds, so hedging the renminbi currency risk was required. Making renminbi the internationalised currency will enable portfolio managers to hedge the risk more easily. Funds Europe: How are foreign investors likely to access China in the coming years – through Luxembourg, or through locally domiciled funds? In general, how do you see globalisation of the China asset management industry evolving? Liu: Hong Kong seems and probably continues to be a pilot market before opening up to other centres. It is the same as with renminbi trading centres. It started off in Hong Kong and then gradually went to London, Paris, Frankfurt and elsewhere. Whether it’s Dublin or Luxembourg, it will just take its turn. Fechter: It depends which investor segment you want to target. What is your long-term planning? If you want to attract Hong Kong private and retail investors, mutual recognition is the best, quickest, easiest way to attract them. If you want to attract international institutional business, you might want to do it via the existing RQFII [Renminbi Qualified Foreign Institutional Investor] quota. You don’t need anything new. If you want to sell your capabilities to retail investors on a worldwide level, I probably would take an established Ucits brand. We see a lot of asset managers from China establishing their subsidiaries either in Ireland, London or Luxembourg to sell these funds internationally. Why? Because Ucits is a trusted product, it has a track record and you can make it clear that this is a product for international customers. Smart: We would prefer to use Ucits pretty much everywhere. We do that with our Brazilian equity manager and our Malaysian sharia-compliant manager. If we have a sale that we want to make in India or Hong Kong or elsewhere, Ucits is the investment vehicle we would like to use. And that’s going to be best for the investor because it gives a nice big fund. However, we’re seeing a lot of passport packages between Malaysia, Thailand, Singapore, Australia and elsewhere. You’ve got these small segments that are trying to be a little bit more parochial. We’re seeing that a little bit with mutual fund recognition here as well. You end up having to re-domicile funds in different locations and that’s not beneficial for the end investor. Cheng: The expansion of the RQFII scheme is a reference point for us. Hong Kong is the first stop for anything. And from a regulator’s perspective there is simply nothing to lose. They want to expand the scheme. ©2015 funds europe

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