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The 2011 China 20: A Weak Market Trumps Growth

A rising supply of shares and declining stock prices challenge China's asset managers.

China may have escaped the global economic slowdown so far, but Chinese asset managers are feeling the pain. Continued weakness in China’s equity market has made this one of the most challenging years for the country’s fund management industry since the financial crisis first erupted in 2007. Notwithstanding the country’s strong economic fundamentals — growth has been running at a pace of more than 9 percent — the Chinese stock market has been among the worst performers around the world. The benchmark CSI 300 index has been weakening steadily since April and stood at 2,679.27 late last month, down 14.4 percent since the start of the year and off a whopping 54.5 percent from the all-time high in October 2007. “The major challenge for us was market volatility and the fact that it has been a bear market,” says Beijing-­based Zhang Houqi, deputy president of China Asset Management Co. Indeed, it’s a sign of the times that China AMC retains its status as the country’s largest asset manager despite a decline in assets under management. The company stands at the top of the China 20, Institutional Investor’s exclusive industry ranking, for a fourth consecutive year, even though its assets slipped to $43.5 billion at the end of March from $45 billion at the end of December 2009. Results are mixed throughout the ranking. Harvest Fund Management Co. ranks second, with $38.6 billion in assets, up from $35.1 billion at the end of 2009; Bosera Asset Management Co. is third, with $28.7 billion in assets, down from $30.7 billion; E Fund ­Management Co. returns in fourth place despite a sharp fall in assets, to $22.3 billion from $27.9 billion; and China Southern Fund Management Co. advances one place, to fifth, in spite of a modest decline in assets, to $17.6 billion from $17.9 billion. The volatility has been challenging for fund managers as industrywide assets under management have seesawed. They peaked at 3.2 trillion yuan ($476 billion) in 2007, fell to 1.89 trillion yuan in 2008 and rebounded to 2.67 trillion yuan at the end of 2009 before declining to 2.3 trillion yuan as of August 31, according to Shanghai-­based Z-Ben ­Advisors, a firm that tracks China’s asset management industry. The scope of the market’s decline in recent years could limit any potential recovery, analysts say. “Many individual funds are currently below their par value, meaning that a large number of investors are holding on to their investments, and many will redeem if performance pushes the net asset value back up to 1,” says Anthony Skriba, an analyst at Z-Ben in ­Shanghai. “This means that, in the event of a near-term market rebound, industry [assets] will decline as investors redeem their existing shares, with growth following thereafter.” To an extent, Chinese equities have suffered from the same decline in valuations that have hit most stock markets around the world as growth has slowed. But several factors made in China are also weighing on the market. The Chinese government has been selling its stakes in a wide range of companies, flooding the market with billions of shares since 2006, notes China AMC’s Zhang. Until 2006 about 55 percent of all shares of publicly traded state-­controlled companies were classified as nontradable. Since then, Zhang estimates, the government has sold nearly 50 percent of those nontradable shares on the market. The government isn’t the only source of supply. Chinese companies continue to bring a steady flow of initial public offerings to the market, albeit not at the same torrid pace as in previous years. Year-to-date as of September 21, 267 companies had issued $41.7 billion worth of equity in IPOs, according to data provider Dealogic. Many of the IPOs are taking place on ChiNext, a Shenzhen-­based market launched in November 2009 that specializes in raising capital for private entrepreneurs. More supply could be coming if the government goes ahead with plans to introduce an international board on the Shanghai exchange, to lure listings from foreign ­multinationals. “Global volatility is one factor affecting China, but domestically there are structural problems,” says China AMC’s Zhang. “There are too many nontradable shares being released, new exchanges being launched, too many initial public offerings all coming too quickly.” Zhang says the market has a digestion problem. “The market has grown far beyond investors’ ability to consume,” he says. “This has benefited the entrepreneurs and corporations, but it hasn’t created wealth for retail ­investors.” Compounding the concerns are market worries that official efforts to rein in inflation, which eased to 6.2 percent in August after hitting a three-year high of 6.5 percent in July, may force the economy into a hard ­landing. Still, Chinese shares have relatively attractive valuations these days, and there are signs in the market that equities have been oversold, analysts say. Shanghai’s A shares were trading last month at an average of 9.3 times forecast 2012 earnings, below the comparable average price-­earnings ratio of 10.8 for stocks in the Standard & Poor’s 500 index, according to Paul Schulte, global head of financial strategy at CCB ­International Securities in Hong Kong. “The A-share market has gone through the toughest part of the derating process,” says Kwok-On Fung, Tokyo-­based head of China fund management at Nikko Asset ­Management Co. “It’s been more than one and a half years since China started the tightening cycle, in early 2010, and there are views that China is close to the end of the tightening cycle. The market valuation has come to an all-time low. I expect 2012 to be better than 2010 and 2011.” Nikko owns 40 percent of Shenzhen-­based Rongtong Fund ­Management Co., No. 19 on our list, with $7.7 billion in assets. The Japanese firm also manages a qualified foreign institutional investor fund that invests an undisclosed amount of money for Japanese clients in China’s A-share market. “We feel economic growth to be strong,” says Desmond Ng, chief operating officer and head of sales and marketing in Asia ex-­Japan at Invesco Hong Kong. Atlanta-­based Invesco’s Chinese joint venture, ­Shenzhen-­based Invesco Great Wall Fund ­Management Co., No. 20 on our list, with $7.5 billion in assets. Ng says the venture favors consumer-­oriented stocks because of the rapid growth of domestic demand and the rise of a middle class in the country. “We do feel the demographic changes continue to boost consumer demand,” he explains. Zhang says China AMC isn’t assuming that the market will rebound anytime soon and isn’t taking anything for granted. The company has been tightening its risk-­management procedures and requires as many as eight signatures from different unit heads for a given trade. “Our chief risk officer oversees each transaction and has the right to refuse,” Zhang says. “Our CEO says our development is like a race car. We must have sophisticated brakes to control. There are times when you must slow down in order to win the race down the track.” Those risk controls appear to be making a difference. Of China AMC’s 114 managed pension funds, only one is down for the year, as of August 31, and that by just 0.47 ­percent. The fund manager’s performance has been particularly impressive because regulators have prevented China AMC from issuing any new mutual funds, the traditional source of asset growth in the industry, since early 2010, pending a change in control of the company. China AMC is owned by Citic Securities Co., but regulators have ordered the securities firm to cut its stake to 49 percent ahead of its own IPO later this year. Citic recently sold 11 percent of China AMC to Southern Industrial Asset Management Co. for 1.76 billion yuan, 10 percent to Power Corp. of Canada for 1.78 billion yuan and 10 percent to ­Shandong Province Rural Economic Development Investment Corp. for 1.6 billion yuan. It plans to sell a further 20 percent shortly.

“China AMC’s individual funds have had strong performance, and overall the firm has been very successful at retaining assets,” says Z-Ben’s Skriba. “China AMC has actually been able to hold its market share relatively constant. This has been done through timely dividend payments that encourage investors to buy into existing products — a rarity in China — combined with strong performance.”