Back in 2007, international observers were upbeat about the prospects of China’s burgeoning asset management industry. According to a report in the McKinsey Quarterly, published by the global consulting firm, the country’s asset management market would grow by more than 24% a year for the next 10 years. “We estimate that the market will grow by 60% annually for the next three years, but high churn rates and fierce competition will force asset managers to hawk their talents to investors more aggressively,” the consulting firm wrote. The report also noted that in some cases, multinational companies with asset-management partnerships in China had earned returns of more than 100%, making the asset management industry even more alluring to international investors.
How times change. These optimistic assessments were made before the financial crisis that erupted with volcanic fury in the fall of 2008 to roil the global economy. Since then, asset management firms across the globe have found themselves positioned at the center of a storm, first because of the roller coaster ride that shook the U.S. stock market and decimated that country’s housing market, and then because of the global recession that threatened the core banking systems of many nations. Even today, European Union members continue to be buffeted by fallout from Greece and other weaker EU participants and question marks hover over the future of the Euro.
China’s economy has hardly escaped the brunt of the global slowdown, and some softening is evident, although the degree to which the country’s economy will be affected is debatable. According to experts from the Wharton School of the University of Pennsylvania and elsewhere, China’s long term economic prospects are strong. Franklin Allen, a professor of finance at Wharton, notes: “I think China will continue to grow at a high rate — maybe not as high a rate as it has done the last few years, but that has more to do with problems in the global economy rather than anything else. I think China’s growth will probably slow to 8% or even 7%, but it's unlikely to go below that, simply because so much of their spending is on infrastructure. China’s current plan is to build out the tier two and tier three cities. That plan will take some time to implement and keep growth high.”
This assessment represents positive news for China’s asset management companies, according to industry experts, who point out that firms that stay alert and maintain a clear focus may be able to ride out the storm. All else being equal, “Companies that focus on best practices that deliver transparency and clarity to clients will be better able to attract and retain investors,” according to Mike Niedermeyer, the U.S. chief executive officer of the Wells Fargo Asset Management Group. “Delivering clarity and performance takes a team approach — the days of one person managing stocks and bonds are over. Today you need a broad but deep group of specialist boutiques that work in a united manner, governed by a set of guidelines that maintain their alignment with customers’ appetite for risk and return.”
An asset management firm that understands this can grow not only by attracting new clients, but by engaging more deeply with existing ones through cross-selling a variety of products, including high yield, short-duration and municipal bonds, alternative investments, and other products designed for current income, long-term growth and retirement planning, he adds.
“Investors tend to react to the most recent moves in the market, and an asset management firm has to be aware of that,” Niedermeyer notes. “So when the stock market is up, for example, they may load up on equities. And if the market falls, they may shy away altogether instead of searching for values that may be temporarily positioned at relatively competitive prices.”
At this critical juncture, investment experts point out that China’s asset management firms should focus on providing quality and value in all their investment offerings. They should also ensure that financial advisors are able to offer investment products that are aligned with their customers’ needs. Now is the time to focus on product quality, whether these products are offered directly by the firm or through external, non-affiliated advisors. Chinese firms that take these steps will be able to offer competitive returns despite a softer economy and a strict regulatory environment.
What Investors Want
“Given the turmoil and volatility that the markets have seen during the last decade, individual investors are seeking more certainty,” according to James P. Dunigan, executive vice president and managing executive, investments at the PNC Financial Services Group. “This may lead them to seek out more alternative investments like hedge funds, which seek to reduce risk by offsetting long positions with short ones and that take other steps to decouple from the stock market while still achieving returns that exceed benchmarks like inflation, or U.S. Treasuries.” At the same time, investment firms have to work hard to retain or, in some cases, win back the trust of investors who have seen the value of their portfolios fall sharply in the wake of market forces.
“All the turmoil and disruption we saw in the past few years drove some people to lose their trust in stock markets,” Dunigan notes. “Investors in general want to be more confident that they are getting good advice.” He adds that uncertain economic conditions have made many investors “more sensitive to the concept of risk management.” These investors tend to be re-examining their own risk profile, and are questioning how it lines up with the way their portfolios are constructed, he says.
“One thing is obvious,” says Dunigan. “Coming out of the downturn, it appears that the portfolios of some investors were not properly matched with their individual risk profile.” Going forward, more asset management firms will have to adopt best practices that call for them to help investors understand their risk profile,” Dunigan adds. “[Asset management firms will have to help investors understand] how their portfolios can be structured to meet those goals within those parameters.” But some investors may be overly conservative, he warns, “and they will find it difficult to meet their objectives given their strong aversion to risk.”
Dunigan recommends that asset management advisors would do well to introduce investors to measured, incremental amounts of risk at a pace that will maintain their level of comfort. “Patience is a large part of this,” he says. “It’s about maintaining discipline in a challenging environment at a time when it’s easy for investors to quickly get turned off the market.”
Changing Market Perceptions
Increased concern over risk represents a major change in market perceptions from the past, when global asset management firms were eager to cash in on China’s economic boom. According to the McKinsey report, between 2003 and 2007 more than 27 global asset managers entered China, mostly through alliances and joint ventures. Despite earning high returns, many of them faced major challenges even then. “For one thing, Chinese investors are extraordinarily fickle,” the report states. “Many shift their holdings out of any given mutual fund within six months. In fact, almost all funds lose their assets under management (AUM) after two years, so companies must constantly launch new funds to win investors.”
The good news is that China’s economic growth has continued to create new investors who are looking for investment vehicles that offer better returns than low-interest paying savings bank accounts. The McKinsey reports points out that while investors in other Asian markets such as Japan took years to embrace mutual funds, in China the rate of adoption could be much faster. The reasons include “the increasing number of workers preparing for retirement, much reduced government pensions, creeping inflation, and a booming stock market.”
Another major factor that could benefit China’s capital markets – and thus the prospects of asset management firms in the country – is the gradual moves the country has been making to globalize the renminbi. This trend will grow even stronger over the coming years, according to Wharton’s Allen. He notes: “China has been doing a number of things recently to move in this direction. For one thing, the Chinese government has been encouraging settlement of trade in RMB. That is growing fast, albeit from a low level, but it is occurring. It will increase, particularly in Asia. The second thing China has been doing is to allow companies to issue RMB bonds in Hong Kong. McDonald's and a number of other U.S. firms have been doing that, and that's again growing quite fast.”
According to Allen, what remains the most difficult is to have “full convertibility of the RMB, both on the current account and the capital account. In the U.S., we tend to emphasize the current account. There is a deficit — particularly a bilateral deficit with the U.S. — but I think the more important issue is what is going to happen with the capital account. The Chinese domestically have relatively few investment vehicles. I'm sure that if the capital account were to open up, there would be a large outflow of RMB. At the same time, I think many people would like to invest freely in Chinese assets and so there would also be a big inflow. It's difficult at this stage to say which of those flows would be bigger and which way the RMB would move in the long run.”
Allen explains that what economists around the world have observed in recent years is that “the capital account has become very important for the determining of exchange rates. A classic example here is Switzerland. I think that is a big issue and although people assume that the exchange rate will strengthen, it's not entirely clear that that's the case. I think when we get the new generation of leaders in China, one of the hard things they'll have to decide is at what speed to move towards a fully convertible RMB. I hope they will do that, and that in maybe five to 10 years, we will have made significant progress in that direction.”
A Disciplined Approach
These market forces should create important growth opportunities for China’s asset management firms. In order to benefit from these opportunities, they will have to adopt a disciplined approach that ensures that all the company’s segments are aligned with the corporate model. PNC’s Dunigan notes that based on the company’s international experience, the compensation structure is a key component of the alignment effort. “At PNC Financial Services Group we have found that that utilizing a salary-based compensation system — with no commission incentives for a particular product — is the most effective approach,” he says. “There are incentives offered, but they are geared towards client retention and other metrics, which makes it easier to align the goals and objectives of everyone at our company, from management to our marketing teams, with the goals and objectives of our clients.”
Recent reports indicate that global economies including China will continue to face a variety of issues — including economic uncertainty and a slow real estate sector — for some time to come, presenting asset management firms with a series of challenges. But experts agree that by aligning internal goals and objectives with client needs, and by maintaining a disciplined strategy even during times of turmoil, asset managers can continue to deliver valuable services to investors.