Industry weighs risks of China's private funds

Private securities managers in China – the country's equivalent of hedge funds – are seeing substantial inflows from foreign institutions, amid concerns over the risks posed by allocating to this nascent industry.

Zhao Kai, chairman of Shanghai-based private asset manager Top Fund, said investors had been allocating funds to firms like his in small amounts on a trial basis. A growing number of Chinese banks and insurers are willing to allocate capital to such funds, he noted.

He argued that the interests of private fund managers – often sole owners of their businesses – were in line with their clients' interests.

But Zhao conceded that corporate governance can be poor among such players. Nine in 10 Chinese private securities firms may fall short of the level of risk controls demanded by overseas institutions, he said.

The high returns on offer from such firms should be balanced against greater risks, agreed Alexis He, an analyst at Shanghai-based consultancy Z-Ben Advisors.

She cited Chinese private managers’ extensive use of financial instruments and greater flexibility in investment strategy – but also pointed to their flow of talent from mutual fund houses and brokerage research departments.

“Compliance and business risks [of allocating to private managers] are still major concerns, especially for QFII and RQFII investors," said He. "Some [overseas investors] started looking at private fund managers two years ago, but they have yet to issue a mandate."

She pointed to extensive due diligence checks being conducted by foreign firms, adding that private fund managers needed to standardise their operations.

Nonetheless, the private securities fund industry is growing fast. A total of 3,163 equity-focused private managers ran assets of Rmb388 billion ($62 billion) as of last November, and grew by 29% year-on-year from the end of 2013 to November 30, according to the China Securities Regulatory Commission. Several star managers from mutual funds set up private vehicles last year, as reported.

Some 89% of China’s private fund businesses are less than three years old, according to third-party distributor Howbuy. Gesafe Wealth Advisory says only 11 of firms had more than Rmb5 billion in AUM as of the end of last year.

Despite the risks, Z-Ben’s He predicted overseas funds would continue to flow to private managers given the growth of RQFII and QFII quota holders, as reported.

Certainly, well-established industry players are getting involved. CSOP Asset Management, the Hong Kong arm of mainland fund house China Southern, launched last August an A-share fund in conjunction with UK-based Hermes Investment using Chinese private managers as sub-advisers. Top Fund is one of the sub-advisers chosen by Hermes.