Foreign fund houses entering China could help country’s beleaguered pensions system

Chinese dragon

China’s funds market will soon be teeming with new mutual funds, as foreign money managers vie to attract capital from the country’s pool of retail investors.

China took a step towards market liberalisation earlier this year by removing limits on foreign companies owning funds businesses.

The first international asset manager to receive approval to set up a wholly-owned mutual fund company in Shanghai, was BlackRock in August. Neuberger Berman and Fidelity International have also applied for licenses, while Vanguard Group, Schroders, and VanEck, are among those reportedly following suit.  

Many foreign fund houses also hold major stakes in joint ventures with domestic firms, which make up more than a third of the 128 mutual fund houses in China and half of the overall assets in Chinese mutual funds, according to data from Fitch Ratings.

JP Morgan has already begun making moves to buy out partners in its joint venture funds business, China International Fund Management Co (CIFM), for an expected cost of USD1 billion.

China is the second largest economy in the world, after the US, the country’s mutual funds hold only one tenth of the assets held in US funds, at USD2.2 trillion in AUM.

This figure is rising rapidly though, with data from ICI Global showing the market expanded by almost 70 per cent in three years to the first quarter of 2020, while global mutual fund assets increasied by just 12 per cent.

Fitch Ratings expects more foreign fund managers to open in Shanghai. “You have this combination of expanding retail wealth, a relatively low rate of utilisation of mutual funds at the moment, and hence that becomes an attractive mix for investment managers to tap into that growth and attempt to expand the share of wealth that goes into funds,” says Alastair Sewell, an analyst at Fitch Ratings.

Many big international players are little-known by onshore Chinese investors, according to Li Huang, another analyst at Fitch. “Not that many Chinese local investors, especially the retail investors, are familiar with these names, so I think to establish their branding in the local market is challenging.”

Huang adds that China also has a “totally different operational environment and a unique distribution marketplace”.

This has often resulted in foreign fund houses finding it difficult to establish themselves and win over local investors.

BlackRock launched its first wholly-owned funds platform in China in 2017 for the private onshore market, a subsidiary known as BlackRock Investment Management (Shanghai) Co, Ltd.

The asset manager "essentially just xeroxed an existing credit product developed overseas, and came in with all manner of guns blazing with their marketing,” according to Nicholas Omondi, a senior associate at Shanghai-based asset management consultancy Z-Ben Advisors.

“They assumed, ‘We're the world's largest manager, we're going to come in, have a marketing blitz, and everyone's going to pay attention to us’, and that didn't really happen. They didn't actually take the time to understand what it was the local investor was after.”

Fundraising ended up being “less substantial than expected”, and BlackRock’s Shanghai subsidiary has since allegedly shuttered some of the products they initially launched on the local private market. BlackRock has not confirmed this, saying that regulations prevent onshore private fund companies from speaking about their funds.

“Operating in the Chinese market is very different from what they are used to globally,” warns Omondi.

One of the key differences when operating in China’s funds industry is the “tremendous popularity” of money market funds like Ant Financial’s Yu’e Bao, which account for around half of Chinese mutual fund assets. In the US, money market funds account for around 20 per cent of the total.

Fitch Ratings’ Sewell says this is likely to influence foreign managers’ product launches. “In the near term, asset managers are likely to explore the money market funds sector, and therefore those international managers with an established franchise in money market funds may be drawn to China.”

Launching a money market fund may help managers avoid some of the challenges faced by international fund houses that have set up in China previously.

On the flip side, if foreign fund managers can successfully introduce new types of investment products, this could add more value to investors and diversify the market.

Omondi notes that in the past, the market “hasn’t really taken to” new initiatives launched by the regulator to diversify the offering of investment products.

“It’s going to have to be an initiative led by the managers,” says Omondi, adding that managers have been “arguably lazy” at providing investment education, which has brought previous attempts to a standstill.

A broader range of investment products could also help prop up China’s teetering pensions system, which is gearing up to start paying out as the country’s workforce continues to age rapidly. The UN has predicted that by 2050, over a third of the population will be over the age of 60.

“What used to be a problem on a 30-year horizon is now looming over the next decade, and so reliance on the public pension fund for your retirement kitty isn't really going to cut it anymore,” says Omondi.

China’s pension payments are higher than most European countries, but this has been undermined by the fact that the majority of employers do not pay the full amount of their mandated pension contributions. The current shortfall in state pensions may amount to USD540 billion, according to experts at the China Academy of Social Science.

Omondi floats the idea of bringing in a “defined contribution style private pension system in China” to broaden the options for retirees.

This would require more types of funds on the market in order to build diversified portfolios, and international asset managers may be able to add value by providing more active management options, as well as varied types of fixed income products and quantitative strategies.