II China report: asset management. Harvest’s landmark

Institutional Investor, September 2009

China report: Asset management

July witnessed something of a landmark in China’s asset management industry. Harvest Fund Management, the biggest of the 32 Sino-foreign joint venture asset management companies in China with over US$29 billion in assets under management, announced a deal with Deutsche Asset Management which gives Harvest control of a raft of Asian equity funds and mandates. It made Harvest China’s biggest cross-border asset manager, and marked a significant step for the industry as a whole.

Under the terms of the deal, a new entity called Harvest Global Investments Limited in Hong Kong takes on the management of all DWS mutual funds with Asian or Greater China equity strategies (DWS is Deutsche’s investment manager brand). Ten Deutsche Asset Management staff will join this new manager and Deutsche, through its stake in the Chinese parent company, will indirectly own 30% of it. Since these funds are sold worldwide, notably in Europe, the deal brings with it a global client base including European pension funds and global insurance clients.

Michele Bang, CEO of the new venture and a former Deutsche employee, calls it “a significant development in the funds management industry. It is a strong further sign of China’s maturing financial services sector.”

She adds: “As China’s market capitalization surpassed Japan this year as the second largest market in the world, [the] global institutional client base will naturally increase exposure to China.” She argues that local fund management companies with strong onshore research and investment expertise are going to play a progressively bigger role for international investors.

Chinese involvement with international investment – whether in building international equity funds for consumption in China, or constructing methods of bringing international money into the country – has so far been somewhat timid. Partly, this is a function of regulation: China’s Qualified Domestic Institutional Investor (QDII) and Qualified Foreign Institutional Investor (QFII) programs set strict parameters on the amount of capital that can be invested in Chinese markets by outsiders, or put into international funds by domestic investors. Several domestic managers have been permitted to launch QDII funds – generally international equity products – but under strict supervision by China’s regulators, and the timing of their launch, just ahead of the global financial crisis, has not helped to bolster their reputation since returns have mainly been poor.

Correspondingly, Chinese managers, with plenty to keep them busy at home, have tended to build modest presences overseas. But this is clearly changing. E Fund Management, one of China’s largest domestic managers, has been among the most ambitious: it received a license from Hong Kong’s Securities and Futures Commission in January for a wholly-owned subsidiary there, with the right to handle both asset management and securities advice. In addition to helping with E Fund’s QDII international equity fund, the subsidiary has also launched a private fund, domiciled in the Cayman Islands: a long-short equity product investing in Greater China. China Asset Management Company (ChinaAMC) is also building a Hong Kong office, with a three year timeframe to build a top-class research team for the Asia Pacific region. And China Southern Fund Management has a joint venture in Hong Kong with the Oriental Patron Financial Group, which advises on the mainland parent’s QDII fund; it has said it is looking for acquisition opportunities perhaps along the line of the Harvest approach. It is also understood to be developing an offshore absolute return fund.

Bang at Harvest declines to reveal how much money goes across to the new venture from the Deutsche funds, saying only “the size is substantial”, and notes that it “is significant not only in size but in that it allows HGI to reach important client segments and markets around the world.” It is perhaps not a surprise that it should be a Sino-foreign JV that should make this step. These ventures are mainly dwarfed by China’s biggest five domestic fund managers (ChinaAMC, E Fund, China Southern, Bosera Asset Management and Hua’An Fund Management), but in overall numbers they account for the majority of mainland managers (32 out of 60) and their importance is growing. And clearly they bring the advantage of a global manager’s expertise.

“As one of the early Sino-JV asset management companies in China, we have spent the last five years working with Deutsche Asset Management in understanding international asset management best practices,” Bang says, citing staff exchanges, joint strategy meetings and senior management interaction from investment management to operations and human resources. “By working with more global investors, the Chinese fund management industry will mature quickly by having to adopt procedures and policies which are accepted more widely around the world.”

Observers are interested. “I think it’s a very beneficial deal for both sides,” says Howhow Zhang, an analyst at the leading fund management research group Z-Ben Advisors in Shanghai, who says Harvest’s A-share expertise will help the Deutsche Greater China funds, and Deutsche’s reach will let Harvest explore the potential of global markets. “Harvest is the only JV to have set up a subsidiary in Hong Kong, and can safely expect help from Deutsche bank to help them expand from there into the international community.”

Whether or not this works, China’s domestic asset management industry appears to be booming again after a difficult 2008. Industry assets under management rose 14.64% in the second quarter alone, to RMB2.3 trillion, a welcome return to form after assets fell from RMB3.2 trillion to RMB1.94 trillion in the space of 12 months last year. The dramatic rebound in China’s stock markets – up over 60% year to date at the time of writing – has not only helped performance numbers but persuaded people to return to mutual funds.

Alongside this are other significant trends. In particular, asset management in China is no longer just about retail: the institutional side is growing, and that is very good news for managers as that money tends to be much less likely to be withdrawn at the first sign of trouble, making it easier to manage for the long term. “Institutionalization is one of the most important trends in the asset management industry in China, especially compared with 2007, when the market was basically dominated by retail investors,” says Zhang. For example Fan Yonghong, CEO of ChinaAMC, says that institutional business has grown from being “a supplement to the retail business” to accounting for 30% of his group’s assets, and he expects it to continue to grow. In particular, the enterprise annuities market is growing strongly; state institutions like the National Council for Social Security Fund, a strategic reserve fund controlled by the central government, and China Investment Corporation, China’s key sovereign wealth fund, are giving out more and more mandates to domestic managers; and insurers are being permitted to invest more widely than their traditional allocation to bonds, and are likely to use fund managers more and more as they diversify.

Fund launches continue at a pace too, with index or enhanced index products the flavor of the month. Recent products linked to returns of the CSI 300 Index have come from Franklin Templeton Sealand, Bank of China Fund Management and China AMC. “It looks very robust: the sales of mutual fund products in the primary market are improving,” says Zhang. “So long as the A share market continues to be strong the mutual fund industry has a very good chance of some material growth in the next six to 12 months.”

If managers do want to build overseas, then the acquisition approach Harvest has used makes a lot of sense. Numerous alliances exist between mainland and Chinese managers – Bank of Communications with Schroders, China Construction Bank with Principal, CITIC with Prudential, ICBC with Credit Suisse, and Invesco with Great Wall Asset Management, for example – and it makes sense that groups like these will use the benefits of expertise in different markets to build from. Foreign involvement in domestic managers is increasing, as demonstrated by the news in July, announced alongside the G8 meeting in Italy, that Assicurazioni Generali is to acquire a 30% stake in Guotai Asset Management for Eu100 million.

But for the big domestic players, there is the real challenge of building overseas expertise from scratch. More than anything, then, the future growth of the industry – for these local houses in particular – will be about getting the right people. More and more competitors, all getting bigger, will fight each other and private equity rivals for a limited pool of staff. Fan, who sees this as a huge challenge, notes that employees cannot share ownership in a company in the same way that they can in some western markets. “How people can work together and stay in the company, that’s a very big challenge,” he says.  “How to solve this problem? You probably need to do something fundamental. You need to create a mechanism to help those people sustaining the company. There could be a systemic change in this area.”