Fat flows, thin profits for mutual recognition managers

Hong Kong fund managers are set to reap $30 billion in inflows from mainland China over the first six months of mutual recognition, according to a consultant.

However, northbound profit is predicted to be thin in the early stages as substantial inflows are largely cancelled out by high operational and marketing set-up costs.

In addition, the fees that could be extracted by Hong Kong fund companies under mutual recognition could end up being low, due to high distribution costs on the mainland.

Around 10-15 Hong Kong fund companies are expected to be the first movers when the fund passport scheme is officially launched on July 1 this year. But with more than 70 potential participants in Hong Kong, $30 billion could be sourced from the mainland in 2015, or about two-thirds of the initial quota of Rmb300 billion ($48.3 billion), according to Shanghai-based consultancy Z-Ben Advisors.

But Felix Ng, Singapore-based associate director at financial research firm Cerulli Associates, is not optimistic about mainland Chinese investors’ demand for Hong Kong funds. “I believe demand for Hong Kong-domiciled funds will be pretty limited in the near term among Chinese investors,” he said.

“With A shares in a strong bull run this year, it is unlikely that Hong Kong products can offer returns that can match their onshore counterparts,” Ng said. The issue is whether Hong Kong products can offer fixed yields over a fixed time horizon, which is the feature that has defined blockbuster products in China’s mutual fund landscape recently, he added.

Yet fees extracted by Hong Kong fund companies under mutual recognition will be low, due to high distribution costs. “Mainland distribution costs are generally higher than elsewhere and many of China’s best distributors may prefer to work semi-exclusively with their JV [joint venture] partners,” noted Z-Ben.

Ng noted that mainland local banks usually take about 50% of the management fee charged, and it can be as high as 70% for smaller fund companies. But if foreign managers choose to go to onshore fund companies as agents, there is likely to be an added layer of fees, he said.

Z-Ben predicts that Hong Kong managers might only be able to retain around 0.25% of their total fees charged from selling mutual recognition funds over the first six months of a fund launching on the mainland. This assumes an extra 0.2-0.25% of agent fees, although the extraction rate could increase after launch distribution costs are amortised.

The consultancy has predicted that Hong Kong funds could generate a total fee pot of $125 million through mutual recognition sales this year, while delivering $75 million in fee revenue (after agent fees). However, the fee revenue may not be enough to cover total costs of between $250,000 and $3 million for each participant, including operations, training, marketing and public relations, personnel and other costs. Such costs could be significantly different among managers depending on the custodial and transfer agent system used.

In fact, high distribution costs and narrow channels in China have been a major concern for Hong Kong managers since before the scheme was announced. Several key Hong Kong managers told AsianInvestor that they worried it would lead to razor-thin profit margins in the initial years of the scheme, as reported.

Z-Ben says that those managers which have mainland JV partnerships and relationship with mainland banks will be the first group to benefit from the fund passport scheme. These firms include Invesco, JP Morgan Asset Management, Schroder Investment Management and BEA Union Investment. However, opportunities are also open to smaller fund companies which only have one or two eligible funds under the scheme.

“They will find a ready list of potential agents and distributors on the mainland outside the big four banks. Regional banks, along with large brokers, have demonstrated the capability to raise assets at levels far above Rmb200 million,” noted Z-Ben.

“These distributors are already signalling their willingness to embrace smaller mutual recognition players and will have a particular appeal to fund companies which want higher service levels and more pointed targeting of mass affluent, institutional and high-net-worth-individual customers.”