Under the hood of China’s AUM opportunity

Institutions like sovereign wealth funds, insurers and pension funds hold the lion’s share and are expanding rapidly.

Assets in Chinese pension funds - ranked among the largest globally by Willis Towers Watson - rose 18 per cent in dollar terms annually between 2010 and 2015 compared to growth of around 6 per cent for North America funds and 4 per cent for those in Europe.

More and more of these funds will be outsourced: total outsourcing from the National Social Security Fund (NSSF) and enterprise annuity schemes rose from RMB 800 billion at end-June 2014 to RMB 1.2 trillion at the end of June 2016 according to ratings agency Fitch.

Chinese insurers, too, have been taking larger bets in order to match their growing liabilities, opening opportunities for third-party asset managers. More funds will also be allocated offshore.

On the retail side savers have been starved of investment vehicles, with a mass of pent-up wealth worth more than $US20 trillion by some estimates.

Given the potential size of the market it is no surprise in a survey of asset managers in the region by Asian Investor in July/August 2016, the largest proportion (47 per cent) picked the Mutual Recognition of Funds (MRF), a scheme under which Hong Kong and Mainland China funds can be cleared for distribution in both jurisdictions, as the best platform in the region for business growth.

Many fund managers are setting up Hong Kong domiciled products to establish a track record (and build sufficient AUM) to allow them to participate.

The extent to which, and when, the vast China market will fulfil its potential for global asset managers depends heavily on the expansion of options available to mainland investors.

The MRF is just one of several schemes designed to ease access to offshore markets, like the Qualified Domestic Institutional Investor (QDII) program and the ‘Stock Connects’ linking the Shenzhen and Shanghai exchanges with Hong Kong.

But efforts to move capital offshore will accelerate only as fast as China’s regulators allow. Any instability in the markets or currency typically prompts authorities to move to stem outflows.

Concern about capital outflows has already delayed the approval of licenses under the Qualified Domestic Limited Partner (QDLP) initiative, which allows foreign asset managers to set up renminbi funds to invest overseas, while mainland approvals for funds under the MRF scheme have also been far slower than.

Meanwhile, clarity on the asset-management services wholly foreign-owned entities (WFOEs) will be able to provide is also eagerly awaited.

Easing inbound

Matters are somewhat simpler for those looking to expand their exposure to mainland assets as China has steadily become more open to inbound investment. 

In February 2016 international institutional investors were granted quota-free access to the $US7.3 trillion onshore interbank bond market.

China also relaxed quota rules for the Qualified Foreign Institutional Investor (QFII) programme, giving license holders an automatic quota based on their AUM, while rules on the Renminbi QFII scheme were relaxed along similar lines in September.

Such efforts are all part of China’s bid to transform the renminbi into a global investment currency — something given an official imprimatur by its inclusion in the reference basket for the IMF’s Special Drawing Rights in October 2016.

By easing quota restrictions authorities aimed to satisfy the demands of providers of global benchmarks for greater liquidity before they include Chinese assets in influential indices.

Such inclusion could in theory dramatically boost inflows to China as investors in benchmark-tracking products would be obliged to buy RMB-denominated assets according to their weightings.

Some estimates suggest the inclusion of Chinese equities in MSCI’s Emerging Markets Index will lead to an initial inflow of around $US20bn, rising to as much as $US180bn if all A-shares are included at their full weight.

However, the events of 2015, in which a collapse in stock prices prompted China’s authorities to introduce emergency measures such as preventing share sales to prop up the market, seriously dampened global fund managers’ enthusiasm about Chinese equities.

The appeal of the onshore bond market, meanwhile, despite superficially attractive yields, is undermined by opaque risk metrics. The yuan’s devaluation since the forex mechanism reform on August 11 2015 (and the official response) have also spooked some investors and called the currency’s liberalisation into question.

Delay ahead

Full capital-account opening, interviewees for this series suggested, is unlikely in China before 2020.

Even then, only a minority of fund managers in a recent ANZ/FT Confidential Research poll said it would be a given allocations to China will rise, owing to structural problems facing the economy (such as rising indebtedness) and country risk.

Indeed, liberalisation is not expected by most respondents to be a big driver in increasing asset allocations to Asia in general.

Given recent events, many are either rethinking their mainland approaches or are content for now to watch and wait.

Whichever the direction of flows, fund managers expect the opening of China’s capital account to increase liquidity in Asia.

But some serious questions remain about the pace and scale of this opening, and hence China’s role in regional asset management, amid a more volatile global environment.

Tim Moloney, Global Head of FX Investor Sales, ANZ

This is an edited version of an article that appeared in the 'Signals from the Noise: Distinguishing Hype from Opportunity in Asian Asset Management’ series, produced in collaboration with FT Confidential Research.