China bond funds flourish amid industry stagnation

Chinese bond funds have seen strong asset growth this year thanks to numerous launches, in contrast to flat or declining AUM for other mainland products, as investors have sought stable income amid equity volatility.

Another driver of the shift into bond strategies have been stricter rules being imposed on bank’s wealth management products (WMPs) and capital-guaranteed funds. This has led to institutions – notably commercial banks – outsourcing more fixed income investments to external managers. As a result, so-called ‘tailor-made bond funds’ are becoming increasingly popular.

Mainland bond fund assets grew by 32% in the first seven months of this year to reach Rmb923 billion ($139 billion) at the end of July, from Rmb697 billion at end-2015, according to the Asset Management Association of China (Amac). 

This comes as overall fund industry AUM slipped 1.4% to Rmb8.28 trillion in the first seven months, largely driven by a 20% drop in balanced fund assets to Rmb1.79 trillion and equity fund AUM shrinking 11% to Rmb680.4 billion. Meanwhile, money market funds only grew 1.3% to Rmb4.5 trillion.

It is not yet clear how much of the rise in bond fund assets was driven by market moves, but Shanghai-based Z-Ben Advisors suggested most of it came from flows into new products from domestic investors.

The trend is in line with a prediction in June by rating agency Moody's that mainland bond funds would boom in the next two to three years on the back of institutional demand, both onshore and offshore.

Retail investors are turning to bond funds in light of stock market uncertainty and because they offer higher yields than money markets, said Liu Shichen, analyst at Z-Ben. Mainland bond funds are offering yields of 4-5%, while those of MMFs have dropped to 2.5%, he added.

Tailor-made trend

Meanwhile, institutional investors – largely commercial banks – are increasingly investing in tailor-made bond funds, Liu added, rather than segregated accounts.

These are products designed for specific institutions that have low annual management fees of 0.25% to 0.50%, excluding custodian fees and other after-sales servicing fees – similar to the typical 0.3% charged for institutional share class products. Typical bond funds charge 0.5% for subscriptions over Rmb2 million. 

Tailor-made products are also different in that traditional bond funds are required to have at least 200 shareholders. Asset managers are increasingly launching funds and counting their own staff as shareholders to satisfy this criterion, even though institutional investors are providing the capital. 

Many Chinese institutional investors now prefer to invest in tailor-made products rather than segregated accounts, due to a waiver of the usual 20% performance fee, said Liu. 

Mutual funds are more regulated than separate accounts and therefore less flexible as to what they can invest in, but in the current environment higher yields are seen as the most important factor. According to TF Securities, mainland banks are looking for annual returns of 3.78% to 4.55% through such outsourced portfolios.

Another benefit of using mutual funds is that the latter are required to provide more transparency, such as regular reports to the regulator, noted Z-Ben’s Liu.

Proliferation of launches

There has been a big rise in the number of tailor-made bond funds being launched in the past few months to cater to growing demand, said industry observers. 

Shenzhen-based Bosera has been particularly active. It has launched 37 mutual funds this year, 17 of which had the characteristics of tailor-made products, in that each raised about Rmb200 million and had about 200 shareholders.

And Beijing-based China Asset Management, the biggest mainland player, launched a series of four bond funds this month, each raising Rmb600 million within three days. 

Industry participants believe the imposition of stricter rules around what commercial banks can invest in to create WMPs is also spurring these institutions to outsource more to bond managers.

China’s banking regulator reportedly further tightened the rules around WMPs – a segment worth $3.8 trillion – by preventing ‘less experienced’ banks from investing in equities and non-standard credit assets, as reported.