Chinese index products face obstacles

The development of index products has made some progress in China, but still faces key issues, according to panellists at an event this month in Shanghai. They also argued that Chinese investor education must be addressed before the qualified domestic institutional investment (QDII) market will really take off.

The SG China Markets Forum, organised by French bank Société Générale, focused primarily on the QDII, with one panel discussing index product development in China.

That panel comprised: Song Hong Yu, head of research at China Securities Index; Zheng Xu, director in the international cooperation and product development department at Yinhua Fund Management; Zeng Fan Qing, head of product development at Fortune SGAM; Joseph Ho, head of ETF sales and marketing at Société Générale; and Frank Benzimra, director of equity derivatives structuring at SGI Index, part of Société Générale.

The index market has continued to grow, they said, thanks to the high liquidity of indexed products, economies of scale, deepening of product knowledge, and increasing demand for both risk management and an improved legal framework.

However, there remain problems affecting the market's development, including asset managers' strategies of seeking higher commissions by selling actively managed funds, said the panellists. The situation is exacerbated -- as in Japan and South Korea -- by regulations allowing the same securities house to sell active funds and exchange-traded funds (ETFs), the former with a significantly higher profit margin.

Nor do system limitations help matters. The separation of the Shanghai and Shenzhen stock exchanges are slowing the pace of ETF development in China, argued the panelists. And ultimately there is a lack of dedicated market educators -- again, as in Japan and South Korea -- since industry players are unwilling to take up this role due to the aforementioned conflicts of interest over active/passive fund selling.

As for investing in overseas assets, ETFs/indices are the most efficient and cost-effective way to manage a global portfolio, argued panellists. And despite the strong performance of the Chinese market this year, there are still good reasons for investors to buy foreign assets, including: sharing of growth in global economic developments, diversification, limited local investment tools apart from equity investments, and expensive pricing of shares on Chinese stock exchanges.

So how much Chinese money is likely to flow overseas -- and where -- under the revised QDII scheme? That was the subject of another panel at the event. The participants were: David Chang, assistant president at GuoTai Asset Management; Dong Bin, head of QDII at Citic Securities; Sandru Lu, a lawyer at Llinks; and Du Jun, head of institutional investment at Fortune SGAM.

The consensus was that there will be a huge increase in product applications under the QDII scheme, which now stands at $90 billion. However, the main issues hindering the market's growth are insufficient investor education and expertise.

Local investors should not only take a close look at the legal framework of all the investable products when considering overseas assets and should not only focus on returns. More, panellists felt that the Lehman Brothers bankruptcy and aftermath has affected local investors' understanding of overseas markets, meaning there will be a discrepancy between local and foreign investors' understanding and execution, even for very simple products.

For overseas markets, it was pointed out, there are more stringent rules and strategy, whereas for the local market there is more flexibility in execution. The panellists felt that a better way to approach this situation is to combine the two approaches.

As for where domestic investors should put their money, participants felt commodities is a promising asset class, due to dollar weakness and the lack of precious metals/resources. They also suggested making some allocation to overseas structured products/derivatives to help achieve a stable return, and for those with a higher risk tolerance making use of statistical/quantitative strategies.

With reference to managing a full global/China portfolio, Citic said it will put 30% in the local market, 30% in overseas markets, 20% in hedge funds and 20% in strategic products. GuoTai will put a large portion in China and India.