New China mutual funds on the horizon

Mutual funds are the talk in Shanghai. The government is expected to clear new regulations permitting open-ended funds by this summer, and fund houses are scrambling to introduce products to a market hungry for new investment vehicles. A Chinese fund manager, tipped by rivals to be ahead of the pack, says speculation that his firm could launch a fund as early as April is overdone. He says the third quarter is more likely.

“We have no experience as a transfer agent,” he says. “We still need to set up a service centre, to hire 15-20 people to work the phones, to train them, to buy the equipment.” For now, his firm intends to do this work itself. Other fund management companies have outsourced this work for existing closed-end fund business. But these prevent investors from switching money in and out, so everyone faces the same problem of building new infrastructure for open-ended products, and without clear regulatory guideposts.

Some foreign fund managers, ebulliently predicting open-ended funds to launch in the next few weeks, are underestimating these bland but crucial points.

Distribution also needs to be ironed out before these funds, according to a domestic fund management executive. His firm wants to sell open-ended funds through bank channels, not through the Shanghai Stock Exchange, to reach a broader retail audience. His firm sees RMB6.7 trillion ($809.43 billion) in individual bank deposits, including some $6 billion worth of deposits in foreign currencies. “These people have a lot of funds and a desire to invest,” he observes.

Local fund managers are also scrambling to put together better investment and research teams. Because of the greater perils of running an open-ended fund in the event of a panic among investors – a frequent event in the A-share world – funds need to stay liquid and diversified in order to survive. Fund managers hope the market is big enough: there are 1100 listed companies and only 20-30% are worth holding. It is unclear how many open-ended mutual funds can fit into this market.

The biggest uncertainty about timing is, of course, what the regulators allow. The recent craze for B shares, now that locals are legally allowed to trade in themarket, has some fund managers concerned. The last thing either the China Securities Regulatory Commission or fund managers want is to launch a new product, and then see the B-share mania turn into a rout that carries A shares with them – an event most fund managers believe is a matter of when, not if.

They are quite confident, however, that barring a disaster in the stock market, demand will be strong. One domestic manager says the preliminary regulations dictate that a fund must raise RMB200 million before it can launch, but he believes an open-ended mutual fund can easily raise RMB2 billion-RMB5 billion. He expects such regulatory details to be officially published within a month.

“China needs to build a product base that’s 100% domestic before it enters the World Trade Organization,” says a foreign investment manager. The authorities are expected to promulgate open-ended mutual fund regulations, “any day after the National People’s Congress meeting this week ... but I’ve been here since 1996 and this law has always been expected to be passed next month.”

Another unknown is how many fund managers, securities firms, or insurance companies will be allowed into open-ended mutual funds. The authorities tended to approve them in batches of three or four for closed-end funds, but it’s anyone’s guess what approach will be taken for a new product.

In the meantime, foreigners are signing memorandums of understanding with the 10 fund managers and 10 banks that will ultimately be allowed into this domestic game. Some of these range from substantial, historic relationships, and others are smoke and mirrors, but with the prospect of real joint ventures under WTO, there will be much attention paid to what domestic firms are doing open-ended mutual fund business, and how successfully.