China: A Wild World For Funds
When Tian Rencan came to Shanghai three years ago to start a joint-venture fund management company, the Fortis Group veteran had every reason to be cautious. The Chinese stock markets in which he would be trading are notorious casinos, with price manipulation, insider trading, and other abuses commonplace. After spending months carefully vetting local fund managers, Tian chose to link up with an outfit called Haitong Securities, one of the largest such firms in China. Fortis -- the Belgian-Dutch financial giant -- then spent 10 months in tough negotiations over the details of their partnership. The final contract included a stipulation that both the chief executive officer -- Tian -- and chief investment officer would be picked by Fortis. "Fortis' reputation is at risk, so we don't want to ruin this opportunity," Tian says.
Now, Tian's hard work seems to be paying off. Up and running since April, Fortis Haitong Investment Management already has $300 million under management -- money that poured into the fund from both mainland retail investors and institutions such as insurance companies. The company has launched its first mutual fund and was scheduled to start another on Feb. 5. Investors, who can buy mutual-fund shares at some local bank branches, are getting a decent return on their money; the Fortis fund is up 15% since its launch. Just as important, they feel they can trust an institution they assume is largely run by the respected Fortis.
Fortis Haitong is one of six joint-venture money management firms that have started funds in China in the past year. They, along with several investment banks, are laying the groundwork for what is expected to be a flood of overseas investment in China's domestic markets as the government gradually opens its financial system. So far, the Western partners in the outfits are all European. Among them are the Netherlands' ING and ABN Amro, Germany's Allianz, and France's Société Générale. A half-dozen other institutions, including the U.S.'s J.P. Morgan Chase & Co. and Franklin Resources Inc., are in various stages of the approval process.
The new fund managers have pulled in more than $2 billion from mainland investors, about 10% of the $20 billion held by all mutual funds. That's a tiny amount in international terms. By all accounts, the new firms are helping to transform the investment and savings landscape in China. "International fund managers are delivering the expertise they promised," says Stuart Leckie, chairman of Hong Kong's Stirling Finance.
The fund management firms are, of course, taking a big risk by plunging into China stocks and bonds. Ever since Beijing created its first modern stock exchanges 13 years ago, its capital markets have been characterized by repeated booms and busts and regulatory chaos. The markets remain hugely inefficient and often corrupt. China's 1,287 listed companies, traded in Shanghai and Shenzhen, are mostly of dubious quality, trade at artificially steep valuations, and are highly illiquid, with two-thirds of the market tied up in untradable state-held shares. That's why funds raised on the domestic stock markets last year amounted to just $7.26 billion, compared with new bank lending of $335 billion.
Making matters worse, most of China's 130 securities companies are badly managed and are under water financially, thanks to aggressive stock trading for their own accounts and heavy borrowing to cover their losses. On Jan. 5, China Southern Securities Co., the country's fifth-largest brokerage, was taken over by state regulators because it couldn't keep up with its debt payments.
Beijing is quietly hoping foreign fund managers and investment banks will raise standards in both financial services and industry in general by demanding more transparency from the companies they invest in. That could push more locals to shift some of the $1.25 trillion they have locked up in low-interest bank savings accounts into riskier investments such as equities. It also could boost the government's efforts to create a functioning pension system. China's $650 billion in pension liabilities are backed by only $100 billion in institutional assets.
Under current law, overseas financial interests can take only a 33% stake in joint-venture fund managers. That will rise to 49% at the end of this year. Some of the minority shareholders, like Fortis, demand substantial management input, while others are passive partners in what are essentially Chinese enterprises. What the foreigners bring to the party is expertise in devising new investment vehicles. ING's China Merchants Fund Management has created a so-called umbrella fund, which allows investors to divvy up their money in three subfunds with different mixes of equities and bonds. In June, Shenzhen-based Boshi Fund Management Co., which is being advised by Barclays Global Investors, started China's first index fund, which tracks an FTSE/Xinhua index of China's 200 biggest listed companies and most liquid bonds.
PROFIT-HUNGRY INVESTORS. What the new fund managers most crave is institutional money. And institutions looking for higher yields than they get on government bonds are interested. Ping An Insurance (Group) Co. and Taikang Insurance Co. have dispatched personnel to learn about risk management and investment strategy at Invesco Great Wall Fund Management Co. China Life Insurance and China Pacific Insurance are in close contact with ABN Amro. Chinese insurers, with assets of $78.5 billion, are permitted to invest as much as 15% of individual portfolios in the stock market through mutual funds.
One challenge for the fund management bosses is to teach their Chinese fund managers to buy and hold. "We have to keep hammering into their minds that we are offering an index fund," says Joseph Ho, regional director for Barclays -- meaning that there is supposed to be relatively little turnover in its portfolio. China's profit-hungry individual investors have the same short-term mind-set. "People think they can trade in and out of funds in a couple of days," says Hwa Dong Liang, who looks after Invesco's joint venture with Great Wall Securities in Shenzhen. "There's a long way to go."
Yet even before the paint is dry on the walls of their new China offices, the fund managers are nurturing global ambitions. In 2002, China agreed to permit institutional foreign investment in Chinese markets, limited for now to $1.7 billion. Ten European and American fund managers have been approved and are planning to utilize their international banking networks to market China products to overseas institutional clients.
Given the questionable quality of most Chinese corporations, such investment will be only for the adventurous. The foreign fund managers argue that their demands for improved transparency and better corporate governance will have a positive influence. But even they admit their impact is limited. "This is only a small drop in a very big ocean," says Christopher Ryan, CEO of ING Investment Management Asia Pacific. "Over time, hopefully the drops will accumulate." Either way, China's new world of funds will be tricky waters to navigate.
By Matthew Miller in Hong Kong