Why Fund Firms Are Gunning for China

Illustrations by Mike McQuade

Illustrations by Mike McQuade

Financial market reforms are helping foreign funds enter what was once a very difficult, closed market.

Aries Tung is a numbers guy. The head of strategy and business development for UBS Group’s asset management unit in China, Tung set up a private fund business there last year despite already having a mutual fund company under a Chinese joint venture. Why? His reply can be summed up in a single word: 120.

That’s how many times assets managed by UBS SDIC Fund Management Co. — the joint venture in which the Swiss bank holds a 49 percent stake — multiplied in the past 12 years, explains Tung, in an interview with Institutional Investor in Hong Kong. He recalls how he oversaw the start of the joint venture’s first retail funds in 2005, and how assets under management at UBS SDIC, which is majority-owned by China’s State Development and Investment Corp., stood at just $250 million a year later.

Today the joint venture’s assets stand at $30 billion, Tung says. “This shows the growth potential of our China business.”

He predicts that UBS’s new private fund business, which targets high-net-worth individuals and corporate clients, can similarly soar 120 times in the next decade, as China has begun welcoming foreign investors without requiring them to set up shop under a joint venture majority-owned by a Chinese company. The market reform has stirred palpable excitement among global asset managers, who see the opening up of the world’s second-largest economy benefiting their own pockets.

A study released in November by Deloitte’s Casey Quirk research unit said that nearly half of the net new money added to the global asset management industry will flow into China by 2019, when the country will overtake the U.K. as the world’s second-largest market for fund firms. Assets under management in China will top $17 trillion by 2030, comparable to where the U.S. market stood in the early 1990s, according to the report.

Major global fund firms have long understood the potential of Chinese markets and the business opportunities they offer — if only there weren’t so many government restrictions.


Z-Ben Advisors, a Shanghai-based consulting firm, says at least 30 firms have jumped at the chance to seek a wholly foreign-owned enterprise license since the Chinese government’s June 2016 announcement that asset managers would be able to operate independently. Previously, foreign fund managers had to operate through joint ventures under which they were restricted to a maximum equity stake of 49 percent. In November vice finance minister Zhu Guangyao said China would remove limits on foreign ownership for local banks and asset managers, according to a Reuters report.

The market-opening measure means foreign firms will have unrestricted access to China’s $400 billion market consisting of high-net-worth and institutional investors. Asset managers are using different strategies to chase these assets, and as recently as late January, Z-Ben data show that only four of the firms with wholly foreign-owned licenses had launched new funds in China: Fidelity International, alternative manager Man Group, UBS, and Hong Kong–based hedge fund Value Partners Group. Fidelity has been the most aggressive out of the gate, with three new funds this year, including an equity fund and two that invest in fixed income, according to Z-Ben.

“We are very bullish on China — it will be the second-largest asset management market for sure,” Jackson Lee, the country head for China at Fidelity International, says in an interview at the firm’s offices in Hong Kong. “We can’t say how large it will be, but it will be a growth market for years to come. We are long on China.”

Unlike UBS, Fidelity International didn’t set up a joint venture in the market, focusing instead on building independent businesses. Fidelity’s new China Equity No. 1 Private Fund and China Bond Opportunity Private Funds No. 1 and No. 2 are a breakthrough for the firm in that they were raised from Chinese clients, according to Daisy Ho, the firm’s managing director in charge of operations in Asia ex-Japan. Previously, Fidelity’s business in China primarily assisted global investors who wanted exposure to Chinese equity.

The firm manages about $1.2 billion in Chinese onshore equities through what is known as a qualified foreign institutional investor program, an avenue into Chinese markets that allows large foreign investors to purchase approved quotas of onshore equities. Fidelity International also has a 460 million-renminbi (about $72 million) onshore investment pool through a separate program that permits managers to raise renminbi-denominated funds in Hong Kong for international investors seeking exposure to China’s fixed-income markets or stocks listed on the Shanghai and Shenzhen exchanges.

“Most of our current AUM would be from global clients interested in China exposure,” says Gary Monaghan, Fidelity International’s investment director in Hong Kong. “We are very excited we now can distribute our products to domestic high-net-worth individuals and institutional investors.”

Fidelity International has about $23 billion in Chinese equity exposure, including its funds in Hong Kong, according to Monaghan. The firm avoided setting up a joint venture with the Chinese state because top executives wanted full control of their operations. Instead, they’ve been building up a presence in China for its regional services as well as to prepare for future growth in the market, says Lee.

“We look at our China business differently than competitors,” he explains. “We don’t say in five years’ time what we want to achieve. The key for us is looking ten years to 20 years ahead and building systems that will allow us to serve clients in different ways.”

Among foreign fund managers, Fidelity International has one of the largest staffs in China, according to Ho. The firm has about 500 people working at a center in Dalian, a northern port city near the Korean Peninsula, she notes. Fidelity Business Services (Dalian) serves the firm’s offices across Asia, including the company’s large sales and fund administration units in Japan.

“It was our tenth anniversary for Dalian last year,” says Ho. “We hire locals. These people can provide a lot of value-added services serving all of Asia.”

With such a large staff, Fidelity’s service center is well equipped to assist future clients in China, notes Ho. “The three new funds are just the beginning of our road map for China,” she says. “We also want to serve Chinese investors’ retirement and wealth management needs.”

Fidelity International’s new private funds business is based in Shanghai, where in 2004 the firm opened an office run by the same team that manages funds on behalf of its global clients. The head count in Shanghai is about 20, mostly analysts and portfolio managers, according to Ho.

“Our analysts in Shanghai are part of our global team,” says Fidelity’s Lee. “Many of the analysts who work for foreign joint ventures look only at China, but Fidelity has a global integrated platform which enables analysts to look beyond China.” Lee says the firm’s global research provides its analysts in China insight into “value chains across different countries and sectors.”

At a recent global research team meeting in London, Chinese analysts from Fidelity’s offices in Shanghai joined global counterparts to discuss investment themes. “The key is getting global insight,” says Fidelity’s Monaghan. “When the topic of electrical vehicles came up, a number of presentations were made by the China-based analysts.”

Moving the Needle

Fund managers are taking different approaches to doing business in China. JPMorgan Chase & Co.’s asset management unit, for example, received a wholly foreign-owned enterprise license in September 2016, becoming the first foreign manager to hold one. But the firm has yet to launch a single fund.

Michael Falcon, J.P. Morgan Asset Management’s CEO of the Asia-Pacific region, says China is a long-term strategy and the firm is still preparing to set up a new fund through its wholly owned operations there. “Both as a global economy and as an asset management market, China is poised to take center stage,” Hong Kong–based Falcon writes in an email. “Powerful growth drivers such as the emergence of institutional investors and households’ evolution from saving to investing suggest that China’s long-term prospects for investment growth may exceed the U.S. and European markets.”

Ordinary investors and high-net-worth individuals “will power China’s growth,” accounting for more than half of the nation’s assets under management by 2030, according to the Casey Quirk report.

The strong growth of the Chinese middle class will contribute meaningfully to the expansion of the country’s asset management industry, says Falcon. Global asset managers that want to fully participate in this “dynamic market” must have the right strategic approach, he adds, “one that appreciates China’s onshore business ecosystem is massive, complex, and entirely unique.”

J.P. Morgan Asset Management is looking beyond China as a stand-alone onshore market by relying on a team of 18 investment professionals in Hong Kong, Shanghai, and Taipei, according to Falcon. They manage cross-border investment strategies that ultimatelymay benefit domestic Chinese investors.

The firm has three strategic approaches to China. First, there’s “China for China,” in which there will be funds with specific themes for Chinese investors seeking to invest onshore; “China for the World,” with fund themes for global investors targeting the country; and “World for China,” which will offer global opportunities for Chinese investors, according to Falcon. As part of this effort, Falcon says J.P. Morgan Asset Management is expanding its trading and research capabilities while hiring more risk officers to prepare for a “massive buildout” in the months ahead.

“China is the only new market in the world that can move the AUM needle,” says Peter Alexander, managing director of Z-Ben Advisors, in a phone interview. “If BlackRock wants to grow, it doesn’t go to Malaysia or Argentina for the growth, but to China because that is the place which will make your AUM grow.”

BlackRock, the world’s largest asset manager, has come to China to set up a wholly foreign-owned enterprise operation. The firm, which managed about $6.3 trillion at the end of last year, obtained a license on Christmas Day, according to Cynthia Ng, a spokeswoman for BlackRock in Hong Kong. Ng declines to comment further on the firm’s plans.

Winning Market Share

Foreign asset managers stand a good chance of winning substantial market share in China, as investors there tend not to be nationalistic when it comes to finance and are searching for best performers, notes Alexander. “Chinese investors will reward those who give them a good return,” he says. “The Chinese financial marketplace is a meritocracy.”

Alexander says that most of the wholly foreign-owned enterprises are gunning for the nation’s $400 billion private fund market, whose assets are tied to high-net-worth individuals and corporate clients. But a bigger market awaits them a few years down the road, when Chinese authorities allow foreigners full access to its retail mutual fund market, which Z-Ben pegs at $1.8 trillion. By 2022 foreign fund managers will be permitted to buy out their Chinese partners in the 125 joint ventures they’ve set up in China — or start their own fund businesses, according to Alexander.

He believes that foreign firms with global market insight and investing experience across a wide range of asset classes stand a good chance of gaining substantial market share — as high as 25 percent in the coming decade. “China is one of the markets that excites people,” Alexander says, adding that on a recent trip to the U.S. and Europe, he was approached by dozens of CEOs of fund firms who wanted to learn more about the country’s market reforms. They were seeking his advice on whether they should be opening up shop in China. “I say ‘Yes, it’s exciting, fast-growing, and big, but the question is how does it fit into your global plans?’” says Alexander. “If China is genuinely a market for you as an organization, then yes, enter sooner rather than later.”

[II Deep Dive: Man Group Forms First Onshore Fund in China]

Investec, a Johannesburg-based banking and asset management firm, is one of those that have yet to obtain a wholly owned foreign enterprise license in China, but that doesn’t mean its analysts or portfolio managers are any less keen on the market potential. “China is not immune to global markets, but it is not that highly correlated to global markets,” says Wenchang Ma, a Hong Kong–based equity analyst and assistant portfolio manager for the $415 million Investec All-China Equity Fund. “It offers diversification benefits for global investors.”

Ma notes that China has its own market cycles, with the most recent bear market being the massive correction in late 2015 and early 2016 that saw the Shanghai Shenzhen CSI 300 Index plummet by as much as 45 percent. The CSI, which was at 4,337 on January 22, had gained 46 percent from the trough of 2,964, in February 2016.

“China is seeing strong growth in the new economy, such as service and consumption industries, which now make up half of the gross domestic product,” Ma says in a phone interview. “The Chinese economy shifted into a consumer service economy in the past decade, and the trend will continue into the next few years.”

China’s economy grew 6.9 percent in 2017, with annual GDP accelerating for the first time in seven years, according to Reuters. The most important factor is supply-side reforms, says Ma, noting that they are being driven by the central government’s decision to curb excess production of steel, coal, and other old-economy industries. “The old economy companies are seeing strong recovery,” she says. “We see cash flow improving. We see more companies with more money to repay debts.”

Allowing foreign fund houses to own their China operations in their entirety is the latest regulatory reform encouraging institutional investors.

Since 2015 foreign investors have had direct access to Chinese equity markets through an equity trading program known as Stock Connect, which links the Hong Kong Stock Exchange with the Shanghai and Shenzhen exchanges. This allows them to trade Chinese equities via the Hong Kong Exchange, and in turn, Chinese investors can trade Hong Kong equities in Shanghai and Shenzhen. A similar program known as Hong Kong China Bond Connect allows foreign investors to access China’s fixed-income market, which Stratton Street Capital estimates at $10 trillion, the third-largest in the world after the U.S. and Japan.

All of these reforms are being applauded globally. MSCI, the equity index firm, announced last year that it would include Chinese equities, known as A shares, in its emerging markets indices. And Citigroup’s emerging markets indices and regional government bond indices announced in March 2017 that they would be adding Chinese bonds.

MSCI’s upcoming inclusion of Chinese A shares has prompted hedge fund manager Value Partners Group — which recently launched an onshore fund for Chinese investors — to consider opening an office in the U.S., according to Value Partners CEO Au King Lun. “The U.S. is the world’s largest capital market,” Au says in an email. “We anticipate rising demand for investment exposure to China with the pending MSCI A shares inclusion.”

Au may be prescient. There is no question that China’s financial market reforms will help investors gain traction in the Chinese markets, which for so long have been so difficult to conquer. Conversely, China-based asset managers, like Value Partners, may find the reforms to be a catapult for their global ambitions.

It’s a virtuous circle, only beginning to take shape.