Asiamoney: a revolution in Chinese asset management

Asiamoney.com, November 10 2010

There is a revolution taking place in the Chinese asset management industry, and it is gathering pace. It is the rise and rise of the private fund industry.

According to fund researchers Z-Ben, 213 private funds were launched in the first half of 2010 with an average launch size of RMB150 million apiece; all told, the 300-350 funds active in this area by now may well have over US$10 billion in assets between them, and it’s growing all the time.

So what are they? Most unusually for China, private funds live in a legal and regulatory limbo – and China, in general, does not do legal and regulatory limbo. They are launched as trusts, putting them under the regulation of the bank regulator, the CBRC, rather than the CSRC like mainstream asset managers; and they represent a host of absolute return strategies, typically launched by top portfolio managers who have jumped ship from the biggest fund management companies in the country.

The biggest names in this industry are already on a par with the conventional  leaders in terms of fund raising; groups like Chongyang, the biggest, are already capable of raising RMB1 billion in a new product launch without breaking much of a sweat. Already, it is an industry with its established heavyweights: Rosefinch, Chongyang, Starrock, New Value, Congrong, Shanghai Elegance.

There are two drivers to their emergence. One is the stringency of regulation around the products that fund management companies can offer in the traditional, CSRC-regulated space. It’s not quite true to see the private fund sector as a direct equivalent of the hedge fund industry elsewhere in the world, since most structures remain long-only equity products investing in RMB-denominated A-shares on fundamentals-based strategies. But it is true that they tend to exhibit more absolute return characteristics than the mainstream: a greater ability to go into cash, for example. Additionally, some quant onshore managers are attempting arbitrage strategies, and it is likely that the emergence of the Chinese Financial Futures Exchange, allowing the development of financial derivatives, will create a greater opportunity for funds that create short positions, synthetically if not actually. The ability to drift away from the benchmark has become very appealing as an alternative in a market where so many other funds slavishly follow A-share benchmarks, whether by design (index funds and ETFs have been exceptionally popular in recent years) or in practice in active funds.

The other driver is the wish of established fund managers to enrich themselves and go it alone. It is difficult for the big home-grown fund management companies to create structures that remunerate their top managers with, for example, equity in the business. By leaving and setting up a private fund under a trust structure, managers are able to start new businesses in which they find it easier to align compensation with the success of the venture. They can also use the 2 and 20 performance fee structures common in western hedge funds.

This has the established managers worried: earlier this year Fan Yonghong, who runs China AMC, by some distance the largest asset manager in China, told me that retaining staff was the single biggest challenge his firm faced because of the emergence of private funds. It has prompted him to call for wholesale changes to governance standards in the industry, allowing new methods of employee remuneration.

But in the meantime, there has been a flood of top talent from one side of the industry to the other. It started with the portfolio managers: Jiang Hui from ICBC Credit Suisse to Starrock; Sun Jiandong from China AMC, Zheng Tuo from Bank of Communications Schroders, Charlie Chen from HFT. But then, the next phase kicked in: not just portfolio managers, but top business heads leaving. Chen Jiwu, deputy general manager at Full Goal, founded Shanghai V-Stone. Yu Luming, CEO of Huashang, founded a private fund with Shanshan Group. Bank of Communications Schroders has been particularly badly hit: Chongyang has now taken its general manager, chief investment officer and chief marketing officer.

Z-Ben sees this as evidence of evolution of this nascent industry, “in stark contrast to the popular image of private funds being nothing more than a single portfolio manager-led shop operating in what was seen to be a largely unregulated environment. No longer willing to be relegated to the sidelines, larger private funds are now pushing hard to develop into full-fledged companies and in doing so seeking to integrate themselves into the mainstream of China’s money management industry.”

But the oddest thing about this whole renaissance is this sense of it taking place out of step with China’s own plans for the development of the asset management industry. This just never happens: the whole process of financial services expansion in China for 20 years has been at a slow and comfortable pace set by the state, with gradual new permissions as the years go by, strictly as and when the regulators want to see them. Private funds appear to have taken the state by surprise, and there has been some sense of the state trying to slow them down, banning trust companies from opening new securities trading accounts in 2009 (which didn’t make much difference, since private fund managers continue to access old trading accounts within trusts). There are also limits on their expansion, since they can only raise funds through mainland institutional investors and high net worth, with retail so far unable to participate.

The crucial moment for this industry will come when the state issues new laws for the sector, loosely referred to as “the fund laws”, and they are expected at any time. When they come, they have the potential to turn this industry on its head or stop it in its tracks. But perhaps that’s unlikely: when China finds a success story within its midst, the savviest thing to do is to keep it in check but allow it to thrive. And China has never been short of savvy.