It hasn't all been smooth sailing for China's fund management industry, notes Fan Yonghong, a veteran of China funds industry, in a recent interview with China Knowledge at Wharton. Launched in 1998 with just a handful of national firms — including Beijing-based China Asset Management Company (ChinaAMC) where Fan is CEO — the industry has had to find its feet in often turbulent times, of which today's global economic turmoil is just one part.
As for ChinaAMC, it has become the country's largest fund management firm. With Fan at its helm since its founding, the firm had RMB 224.7 billion (US$35.2 billion) in assets at the end of 2010 and a market share of 10%. The firm offers 24 open-ended funds and two close-ended funds. By the end of June this year, ChinaAMC delivered some RMB 72 billion of dividends to 16 million investors since its founding.
Below are edited extracts of the interview in which Fan discussed his vision for China's young fund management industry, its highs and lows, and the regulatory barriers holding back the industry today.
China Knowledge at Wharton: As a veteran fund management executive, could we begin our discussion by asking what you see as the development milestones of China’s asset management industry?
Fan Yonghong: In 1998, the China Securities Regulatory Commission approved the first nation-wide fund management companies. That was a very significant event as it marked the beginning of the industry. Over the subsequent 13 years, the industry grew quickly from around RMB 10 billion to more than RMB 2 trillion. By the end of June this year, the industry had generated total returns of RMB 690 billion. While the industry was finding its feet, an entirely new pool of professional fund managers needed to be developed at the same time that the general public was learning the ropes of personal finance and the country’s capital markets were taking off.
China Knowledge at Wharton: Even though the fund industry in the U.S. goes back almost 100 years, are there any similarities between it and China's industry? What are the differences?
Fan: The American and Chinese industries certainly have different roots, intertwined with their own political, economic and cultural needs.
Because fund management is a foreign concept in China, we have had to look outside the country to find what we could adapt from American and other Western funds for everything from regulations and public disclosure to product design and customer service. We learned a lot, which is one reason why the industry has developed so rapidly in China.
In 1998, Chinese securities companies set up 10 national fund companies, including ChinaAMC, under the guidance of the government. This was a time when markets were also dealing with the financial crisis in Southeast Asia of the late 1990s. Since then, funds have grown stronger and developed through continuous institutional innovation and "de-regulation" – that is, the easing of the stringent regulatory policies put in place during the industry's early days.
In contrast, American funds emerged in the private sector in the 1920s, with the government adding new regulations and oversight bodies over time. That means U.S. funds went from being completely unregulated to regulated, but without restricting the incentives of individual fund companies to innovate and grow. Today, the regulatory policy in the U.S. has become more focused on protecting the rights of investors.
While the fund industries in the two countries have taken different paths in terms of their development, they have actually converged. Both follow fundamental market principles and see asset management as a fiduciary industry. Both are based on trust and the view that human capital is a key competitive differentiator for fund management companies.
China Knowledge at Wharton: What obstacles have China's funds encountered?
Fan: It has not always been smooth sailing and the industry has gone through a number of peaks and troughs, which can be divided into four phases.
The first phase was when 10 fund companies pioneered the industry’s development. By 2000, the size of the industry had reached about RMB 50 billion. This phase also coincided with the arrival of new systems for investment research, product design and service.
The second phase, between 2001 and 2005, was a trough after the so-called “Fund Conspiracy.” A lot people were skeptical about the industry, and that had a negative impact on its growth. But it never came to a complete standstill despite the setbacks. The biggest achievement during this time was the launch of open-ended funds.
The third phase was a great leap forward. From 2005 to 2007, funds entered a bull market. With groundbreaking reform addressing shareholder structures of listed companies in 2005, the capital markets got a new lease of life and experienced explosive growth. It also marked the beginning of a period of rapid growth for the industry, with the total value of funds under management growing from about RMB 300 billion in 2005 to a peak of RMB 3.3 trillion in 2007. But as growth surged, aggressive sales tactics that could raise as much as RMB 100 billion in just one day set the stage for seriously large losses later on.
The fourth phase saw a return to rational behavior. The bear market after the global financial crisis hit in 2008 and 2009's bull market was followed by fluctuations in 2010, causing funds to go through a number of peaks and troughs.
Today, 65 companies manage approximately 900 funds, worth approximately RMB 2.36 trillion. The industry has shrunk and is relatively stagnant. People have changed their attitudes, emphasizing rational evaluations rather than an over-praising [of companies]. I expect this phase to continue for a while longer.
China Knowledge at Wharton: What challenges does the industry face today?
Fan: Chinese funds face both internal and external challenges.
First, the international capital markets and the market for "A Shares" [China-listed firms] have entered a post-financial crisis period, in which developing countries face a number of issues — political uncertainty, economic woes, frequent natural disasters and so on. On top of that, the American debt crisis and the downgrading of its debt by Standard & Poor’s have had a tremendous impact on the market. Even mature markets face rather extreme fluctuations. In the near future, A Shares will be relatively volatile. It will be very difficult to realize large gains through aggressive investing. Mediocre fund performance or even losses will make funds less attractive to investors. Some investors will shift to lower-risk products that offer more stable returns.
Second, a diversification of assets means investors have a lot of public and private vehicles to choose from – ranging from products offered by banks and securities companies, funds similar to hedge funds in other markets, private equity, and investment-linked insurance products. The fund industry's loss of its leading position is a challenge.
In the meantime, we are facing internal institutional challenges because of the gap between the interests of investors and fund managers. Part of the reason is because while current regulations prohibit mutual funds managers from buying stocks personally to avoid conflict of interests, similar rules do not exist for private-capital raising or trust funds. Many excellent fund managers have been jumping ship and leaving the fund industry. That is causing extremely high turnover at fund management companies.
Without stable management and investment teams, it is impossible for companies to perform well. This is a much larger challenge for China's fund industry than any market or competitive pressure. Finding a resolution is urgent.
China Knowledge at Wharton: With the market uncertainty, making money is very difficult. Is that the largest threat to the funds industry?
Fan: The declining market has certainly caused some investors to lose confidence in the fund industry. Some are even pulling their money out. On the surface, this problem is the result of sliding values since the whole reason for playing the game is to make money. But while a gain in the stock market does open opportunities for funds, a fall isn't the biggest threat.
There are two reasons for this. In a bear market, talented fund managers can reduce losses from systematic risk by analyzing downward movements of stock prices. At the same time, by carefully selecting under-valued stocks that have a good chance of rebounding, and buying at the right time, extra profits can be generated. In 2008, top-performing stock and balanced funds lost less than 40% of their value, compared with the Shanghai Composite Index's loss of more than 65%.
Also, after the Shanghai Composite Index broke 3,000 points in February 2007, it has hovered around there throughout the many bear and bull markets over the following four years. In July 2009, the index returned to 3,000 points for the first time since 2008's market collapse, and it did so again in March this year. Over a period as long as four years in which the index has basically seen no increase, the value of more than 300 stock and balanced funds has increased about 15% on average. These funds clearly beat the index, making substantial absolute returns and demonstrating the viability of funds as investment vehicles. Most investors recognize this and maintain a rational view of fund investment.
While a new fund might now struggle to raise less than RMB 1 billion through a public offering on the A Shares market, the value of private funds on the same market has been increasing continuously. In the first half of 2011, more than 350 private trust funds were launched, raising about RMB 30 billion to increase the overall value of private equity to RMB 140 billion. One private fund is said to have raised more than RMB 10 billion. This suggests that market turbulence is not the main reason why fund values have decreased. Fund performance matters.
In terms of how to pick good growth stocks, we need to return to fundamental research and value investment. A fund manager must do independent, in-depth research before buying a company's shares, and fund companies must make retaining and training their research personnel a priority.
China Knowledge at Wharton: What advice do you have for the asset management market?
Fan: More uniform regulations are required, especially for high-risk products. Right now, standards for mutual funds are quite high in terms of, for example, financial disclosure, contract management and a code of conduct among personnel. But these regulations don't cover most other financial products. Even though all the products compete in the same market, different products have different regulatory levels, which is unfair for mutual funds. For the same types of high-risk asset management products, I think regulatory standards need to be unified to create a fair and more competitive environment and bolster investor confidence, while maintaining the credibility of the asset management industry.
On top of that, the investment capacity of the industry can be further leveraged in other ways and opened as much as possible. Like with the U.S.'s 401k pension funds in the 1980s, China should consider developing its pension funds more and entrust their management to investment professionals. With policy support and a good institutional foundation, pension funds could grow, benefitting the entire fund industry.
China Knowledge at Wharton: What are the sticking points with regards to China's regulatory environment?
Fan: With each phase of de-regulation, new opportunities have appeared. However, previous de-regulation was centered on product design, investment and business. Now, we're at a critical stage in which we need deeper thinking about institutional development, such as corporate governance.
The key is to align the interests of investors and fund managers so that they share both the risks and the gains. In this era of more diversified investments, public-offering funds need to open our minds and establish new fund management institutions.
China Knowledge at Wharton: How do you see the future of China's fund industry?
Fan: Even though Chinese funds are in a relatively stagnant period currently, once problems with market fairness and institutional bottlenecks are resolved, the industry will be reinvigorated and reach a new peak. Given the strength of China's economic growth, the healthy development of its capital markets and the gradual increase in the Chinese public's awareness regarding personal financial management, this is inevitable.
From a macroeconomic perspective, China's economy is on the verge of a new cycle. I believe that by the start of the next bull market, the country, hopefully, will have several hundred new fund companies, several thousand fund sales companies and more than 10,000 fund products. A lot of Chinese asset management companies will be on par with their international peers. The Chinese have the wisdom, capacity and confidence to realize this vision.