China’s November surprise

The National Council for Social Security Fund hands U.S. money managers a near-clean sweep.

While visiting Beijing in February to explore long-term business prospects, T. Rowe Price Group’s international chief, Todd Ruppert, called on the National Council for Social Security Fund. Although Ruppert had been to China previously, the right opportunity for entering the market hadn’t come along. That’s why he never would have expected that just nine months after that visit his firm would win the right to manage U.S. stocks for the NCSSF. But that’s exactly what happened in November, when China’s biggest and most prestigious institutional investor awarded its first overseas mandates. T. Rowe was one of just ten mostly U.S. managers to receive allocations -- coveted by more than 100 firms -- estimated at about $1 billion in total (terms weren’t disclosed).

T. Rowe’s mandate provides the firm with a window into China’s surging market for fund management. “Winning places us in a position to watch the marketplace with a closer degree of scrutiny,” says Ruppert.

Building business in China frequently means demonstrating a long-term commitment to the country through investments in joint ventures, staff training and technology transfers. But under the progressive leadership of vice chairman Gao Xiqing, who was appointed in 2003, the fund awarded the mandates solely on merit. Seven of the ten winning firms have no direct presence in China. Of these outsiders, a pair of firms won two mandates each: AllianceBernstein, which will manage global (ex-U.S.) stocks and global bonds; and BlackRock, which will steward global bonds and foreign currency cash management. The other winners are AXA Rosenberg Investment Management and State Street Global Advisors, which will also oversee a global (ex-U.S.) allocation; Intech (Janus Capital Group’s Enhanced Investment Technologies), which joins T. Rowe in overseeing U.S. stocks; and Pacific Investment Management Co., which will run global bonds.

Of the 20 foreign firms with joint venture fund managers on the Chinese mainland, only Allianz Global Investors, Invesco Global Investment Funds and UBS Global Asset Management won mandates (the last was advised by investment bank China International Capital Corp.); all three will manage Hong Kong stocks. Firms that were hotly tipped to win mandates but that walked away empty-handed include HSBC Investments, JPMorgan Asset Management subsidiary JF Asset Management and Schroder Investment Management.

New Yorkbased Mercer Investment Consulting advised on the mandates, and NCSSF received praise from consulting firms and fund managers alike for its handling of the selection process. Stuart Leckie, founder of Stirling Finance, a Hong Kongbased consulting firm, says that the fund laid down benchmarks, demanded outperformance net of fees and even anticipated tracking errors. “That’s pretty sophisticated by Asian standards,” he says.

In an August interview with Institutional Investor, Gao noted that his fund had worked out an extensive set of procedures to ensure that the process was equitable. “We want to make sure that all the people involved feel we are fair and that we have a quite professional way of dealing with them,” he said.

Although the mandates are small, the opportunity for more business is substantial: Fitch Ratings forecasts that the fund’s current $30 billion in assets will grow to $125 billion by 2010.

The winners also have the opportunity to leverage their success to build business elsewhere in China. T. Rowe Price’s Ruppert says that his firm’s mandate will “help get our name out there” and provide an “ancillary halo effect.” Bernard Reilly, head of State Street Global Advisors for the Asia-Pacific region, excluding Japan, says that “being there early on was really important.” Ilex Lam, Intech’s Hong Kongbased head of Asia-Pacific, expects his firm’s mandate to help with business development across the region. “We believe we will receive much greater interest in our investment strategies,” he says.

A key question is whether the fund’s meritocratic approach will prove to be a harbinger of change. Many investors attribute this breakthrough to Gao, a U.S.-trained lawyer and former investment banker who helped set up China’s stock exchanges in the early 1990s and went on to serve as vice chairman of the China Securities Regulatory Commission.

“Credit has to go to Gao Xiqing because he is looking to do what is best for the fund as opposed to what is perhaps politically correct,” says Peter Alexander, head of Z-Ben Advisors, a Shanghai-based fund management consulting firm.

The importance of sound money management has been underscored by a recent scandal in which a third of the Shanghai Municipal Labor and Social Security Bureau’s $1.2 billion city pension fund was allegedly misappropriated. The scandal could lead many of China’s public funds to follow the NCSSF’s example. “A lot of provincial and municipal pension funds could start outsourcing assets, which is potentially a huge boost for fund managers,” says Alexander.

Pension funds aren’t the only possible source of new business in China. There are growing opportunities to serve domestic fund managers and banks by managing products invested in foreign assets under the country’s qualified domestic institutional investor program. Chinese insurers also are looking to invest offshore.

Hong Kongbased Andrew Lo, CEO of Asia Pacific for Invesco Asia, says the potential is huge. “Over time, as Chinese entities become more sophisticated, they will have to diversify their investment portfolios,” he says, noting that China’s State Administration of Foreign Exchange has more than $1 trillion in assets and is increasing its investment personnel. Foreign funds will be watching impatiently, readying their pitches.