This time last year, mainland Chinese investors couldn't get enough of mutual funds. Encouraged by rising prices on the Shanghai and Shenzhen exchanges, they plowed $11.6 billion into equity funds in March and April of 2004 -- far surpassing the $7.1 billion raised in all of 2003. By yearend, funds under management by investment houses in China had doubled, to $42 billion. "Everybody was buoyant and overoptimistic," recalls CEO Tian Rencan of Fortis Haitong Investment Management Co., which lured $1.58 billion into its new stock-and-bond fund last march March. The market was so frothy that "even we thought during the launch that it was about to correct."
Correct it has. Spooked by corporate and market scandals, Chinese investors began shunning the market in late April, and the Shanghai A share index finished 2004 down 16.3% and have rebounded just 3% so far this year. BOC International Investment Managers, a Shanghai joint venture between Merrill Lynch (MER) and Bank of China International, raised only $129 million when it floated a new stock fund in December that starts trading on Feb. 23. While surprised, "we feel ultimately what matters is the longevity of the fund and how well it's managed," says David Peng, the firm's deputy CEO.
The environment is a challenge. Many stocks are near six-year lows. And with 45 fund-management firms -- 12 of them foreign joint ventures -- margins have shrunk. New funds charge fees of as little as 0.5% up front and 1% annually. That compares to the 5% front-end loads in developed nations. That isn't stopping them from issuing new products, though. One growth business is money-market funds, which now account for 20% of funds under management, compared with 3% a year ago.
Competition will only intensify. On Feb. 20 the China Securities Regulatory Commission gave commercial banks the green light to sell stock, bond, and money-market funds as part of a deregulation push. Fund managers have relied heavily on banks and securities firms to distribute their products. In return the banks got a share of front-end loads. Now institutions such as Industrial & Commercial Bank of China, which has more than 30,000 branches, can use their huge networks to flog their own investment products. "The fund-management industry in 2005 is going to have a challenging time in China," says Solange Rouschop, deputy CEO of ABN Amro Xiangcai Fund Management Co. (ABN) in Beijing.
There is a silver lining: The market turbulence gives managers a chance to prove their mettle to investors. But that's not easy. Few listed companies boast strong financial fundamentals and corporate governance, so most pros hold the same few stocks, such as Baoshang Iron & Steel and China Yangtze Power. Still, some funds stand out. Last year, ABN Amro's $52 million Growth Fund earned a 17% return. Indeed, six of the 10 best-performing funds last year were managed by joint ventures, though they account for less than 20% of the market.
Despite the current lull, few investment houses are pulling back. More than $1.5 trillion in personal savings sit in Chinese bank accounts earning paltry interest. Fund managers are also eyeing the $15 billion in China's national social security fund. Beijing has indicated it wants that money invested in low-risk products such as bond and money-market funds. Also, huge growth is expected in private pension schemes and fund management for cash-rich Chinese corporations. The prospect of tapping into those massive pools of money may be too much to pass up -- no matter how bad the market is now.
By Frederik Balfour in Hong Kong