The last laowai standing
Denis Lefranc, head of Fortune SGAM Fund Management in Shanghai, might well be one of the few laowai (foreigners) remaining in an influential position in ChinaÆs fund industry.
Denis Lefranc runs Fortune SGAM, a joint venture between Baosteel Group and SG Asset Management. AsianInvestor recently spoke to him in Shanghai about his experience in the mainland and his QDII plans.
What is your background?
I have a double degree in law and finance from France. I started my career in investment banking-like products at SG Group then moved on to its legal department. Later, I went into alternative asset management for SG, working on hedge funds, futures funds, etcetera. I was already covering Asia at length. Then I moved on to SGAM as a general counsel where I was in charge of all legal and compliance issues.
How did you end up here in Shanghai?
As general counsel, I was in charge of negotiating the joint venture agreements for Fortune SGAM in China. The work was most interesting so I asked the chairman of SGAM, ôWonÆt it be interesting not only to negotiate the agreements, but also to stay and develop the business here?ö That was in 2002. It has been only five years but it already seems such like a long time. China has changed very quickly. The face of the country today is completely different from back then. I remember when I went to the CSRC [China Securities Regulatory Commission] to take the exams, they were quite surprised to see me. I was the only foreigner to work for a Chinese fund management company.
What do you make of the Chinese fund industry?
TodayÆs China stock market is a value-oriented/stock-picking market. Bear also in mind that the industry is very retail-focused these days. The current state of the regulation, along with the lack of sophisticated instruments in the market, makes it difficult to be creative in terms of product design. A lot of equity funds are still very similar today in China. For the same reason, it is very difficult to create, say CPPI-like guaranteed funds providing the unit holders with a trustful guarantee along with interesting potential financial performances.
Fortune SGAM is a venture between SG Group and the ChinaÆs largest steel producer, Baosteel Group. We are currently managing the equivalent of $10 billion in China. We have built a very good and unique business here. Our products are distributed through the main banks, such as China Construction Bank and Bank of China, and also through the fifteen biggest securities companies. Our distributors are quite happy as all our products keep posting steady and healthy performance figures. We have just received our QDII license, which makes us one out of the only six companies that have been authorized to invest overseas.
Can you describe your companyÆs investments?
Unlike most traditional fund houses in China, we rely a lot on detailed, sound, international-like investment process. What we are bringing in is a system, an international process. But we respect local knowledge and the local market dynamics.
We have different styles in our equity funds. Our investment decision committee works out the monthly asset allocation and the top holdings, and it assesses the consistency between investment process and actual decisions. We have tools here to monitor the tracking error of the funds in view of benchmarks and the liquidity of the portfolio on a daily basis. Within a limit set by the investment decision committee, we have a stock pool that the managers can then pick the stocks from.
The stock pool comes with three tiers. You have the tier-one stocks, which are what we consider as liquid and high quality companies with good financial supports. Tier-two is used for diversification purposes. Then tier-three is for new investment idea generations. Portfolio managers can only put less than 3% of their portfolio on tier-three stocks. This is why I believe the performances of our funds are relatively stable. I am not interested in a fund in which we will see performance 20% up one month, and 20% down the next month.
Do you have new products on the market?
We have launched very recently a new sector rotation fund, as sector dominance trends tend to be increasingly more difficult to catch, as popular investments themes progressively vanish along with the still buoyant equity market.
Would cyclical returns be a problem in a bull market?
The first fund had excellent performance during bearish markets in 2003, 2004 and 2005. It was ranked as the top-performing fund during this period. But in a bullish market, when all stocks move up, its rankings come down. So we learned and developed new strategies. We have the advanced-growth fund, we have the multi-strategy funds, which are much more dedicated to tracking closer to top performing industries.
What about bonds?
If you are a credit analyst here, you have very few concerns regarding the credit risks for bonds. They are all government bonds or big agencies carrying government stamps with government guarantees. They are all triple-A-rated, so in theory, you have no credit risk. For these you donÆt need to rely on a rating agency.
As for the corporate bonds, itÆs a new market. Credit rating agencies are not fully developed. You have almost no secondary market for these bonds. A liquid secondary market is necessary if we are to invest as a fund manager. There is a clear need to develop more studies regarding these issuers. That is to change with the latest reforms. We are all looking forward to these changes. But I donÆt think there are so many fund managers today banking in a lot of corporate bonds. We need to wait, firstly from a business point of view, and also for the market to develop.
What is the overseas investment quota you have received?
We are a fund management company so we have a quota of $2 billion. Safe [State Administration of Foreign Exchange] has authorized the same amount for the six authorized fund houses for QDII. However, since the first QDII fund from China Southern Asset Management was a big success, Safe might double the limit to $4 billion. And all other fund houses are trying to go for the new limit, ourselves included.
What are your plans for QDII?
QDII is extremely important for us. We want to bring in our international expertise to the Chinese market. Roughly, SG Asset Management is covering 99% of the global market capitalization. We are capable of introducing products invested in all the main markets in the world, even all the big emerging markets. We feel we can offer more in designs and we have to work quicker.
Gabriel Gondard, our deputy CIO, is in charge of QDII product development. After seven years at SGAM, he has been working in Fortune SGAM for two years. Another Chinese fund manager who has worked in the US for 10 years will run the team with Gabriel.
Our first product is ready. We have submitted our product to the CSRC for review. This is why I cannot give you any more details. But I can tell you it is not a fund of funds. It will be directly invested into foreign stock markets and we will have real key decision centre in China. And we use the direct advisory capability of SG Asset Management. But all the responsibility of the investments and all the decisions will be made in China. Everything else required û compliance, trading, clearing û will be done in Fortune SGAM. We are working on a product that will be directly invested in international stock markets. But it wonÆt be a global or worldwide allocation. It wonÆt be a copy of the Southern fund. ItÆs a completely different product.
SGAM is a major product provider for structured products in international markets. How is it reflected in your China joint venture?
It is a market situation and a regulatory issue. Although the SGAM Group is a big leader in guarantees and other alternatives products, we have never launched one in China so far. My analysis is very simple: because of market issues (lack of instruments and so on) it is difficult to launch a CPPI product in China which can deliver a real good performance. And we donÆt want to launch in China a product whose performance does not completely fulfil the expectation of Chinese investors. ItÆs a long-term view. If you sell a fund with bad performance to a distributor, youÆre jeopardizing future opportunities.
There are more financial institutions authorized to go into the QDII business in addition to banks and fund houses. There will also be insurance, trust, and securities firms. How do you see the landscape changing?
CSRC, our regulating authority, has signed memorandum of understanding with 35 countries so far which means in terms of product design, our scope is much more open than banksÆ QDII products, which are mostly using products that are registered in Hong Kong. We are in the same family in the financial industry. But we have completely different investment scope. Of course, I canÆt say the same for insurance and trust companies. Their QDII programs are completely new.
You donÆt speak Mandarin and you are French. Doing business in China is about building guanxi û the right access to those in power. How does that affect your business?
Language is not an issue. Simply do what you say and let people know you are serious. Our Chinese partners are very strong. They have a lot of connections for sure. I was in China with no relationship from the start. Here, you build trust and relationships over time by committing and delivering. I go to Beijing very often, for at least twice a month to meet with the regulators and partners. We have been working together for five years now. Sometimes there will be personnel changes. The officials have their own careers. But I keep visiting. They know if you are committed and if you are doing your job. ThatÆs all, but it works.
What is your background?
I have a double degree in law and finance from France. I started my career in investment banking-like products at SG Group then moved on to its legal department. Later, I went into alternative asset management for SG, working on hedge funds, futures funds, etcetera. I was already covering Asia at length. Then I moved on to SGAM as a general counsel where I was in charge of all legal and compliance issues.
How did you end up here in Shanghai?
As general counsel, I was in charge of negotiating the joint venture agreements for Fortune SGAM in China. The work was most interesting so I asked the chairman of SGAM, ôWonÆt it be interesting not only to negotiate the agreements, but also to stay and develop the business here?ö That was in 2002. It has been only five years but it already seems such like a long time. China has changed very quickly. The face of the country today is completely different from back then. I remember when I went to the CSRC [China Securities Regulatory Commission] to take the exams, they were quite surprised to see me. I was the only foreigner to work for a Chinese fund management company.
What do you make of the Chinese fund industry?
TodayÆs China stock market is a value-oriented/stock-picking market. Bear also in mind that the industry is very retail-focused these days. The current state of the regulation, along with the lack of sophisticated instruments in the market, makes it difficult to be creative in terms of product design. A lot of equity funds are still very similar today in China. For the same reason, it is very difficult to create, say CPPI-like guaranteed funds providing the unit holders with a trustful guarantee along with interesting potential financial performances.
Fortune SGAM is a venture between SG Group and the ChinaÆs largest steel producer, Baosteel Group. We are currently managing the equivalent of $10 billion in China. We have built a very good and unique business here. Our products are distributed through the main banks, such as China Construction Bank and Bank of China, and also through the fifteen biggest securities companies. Our distributors are quite happy as all our products keep posting steady and healthy performance figures. We have just received our QDII license, which makes us one out of the only six companies that have been authorized to invest overseas.
Can you describe your companyÆs investments?
Unlike most traditional fund houses in China, we rely a lot on detailed, sound, international-like investment process. What we are bringing in is a system, an international process. But we respect local knowledge and the local market dynamics.
We have different styles in our equity funds. Our investment decision committee works out the monthly asset allocation and the top holdings, and it assesses the consistency between investment process and actual decisions. We have tools here to monitor the tracking error of the funds in view of benchmarks and the liquidity of the portfolio on a daily basis. Within a limit set by the investment decision committee, we have a stock pool that the managers can then pick the stocks from.
The stock pool comes with three tiers. You have the tier-one stocks, which are what we consider as liquid and high quality companies with good financial supports. Tier-two is used for diversification purposes. Then tier-three is for new investment idea generations. Portfolio managers can only put less than 3% of their portfolio on tier-three stocks. This is why I believe the performances of our funds are relatively stable. I am not interested in a fund in which we will see performance 20% up one month, and 20% down the next month.
Do you have new products on the market?
We have launched very recently a new sector rotation fund, as sector dominance trends tend to be increasingly more difficult to catch, as popular investments themes progressively vanish along with the still buoyant equity market.
Would cyclical returns be a problem in a bull market?
The first fund had excellent performance during bearish markets in 2003, 2004 and 2005. It was ranked as the top-performing fund during this period. But in a bullish market, when all stocks move up, its rankings come down. So we learned and developed new strategies. We have the advanced-growth fund, we have the multi-strategy funds, which are much more dedicated to tracking closer to top performing industries.
What about bonds?
If you are a credit analyst here, you have very few concerns regarding the credit risks for bonds. They are all government bonds or big agencies carrying government stamps with government guarantees. They are all triple-A-rated, so in theory, you have no credit risk. For these you donÆt need to rely on a rating agency.
As for the corporate bonds, itÆs a new market. Credit rating agencies are not fully developed. You have almost no secondary market for these bonds. A liquid secondary market is necessary if we are to invest as a fund manager. There is a clear need to develop more studies regarding these issuers. That is to change with the latest reforms. We are all looking forward to these changes. But I donÆt think there are so many fund managers today banking in a lot of corporate bonds. We need to wait, firstly from a business point of view, and also for the market to develop.
What is the overseas investment quota you have received?
We are a fund management company so we have a quota of $2 billion. Safe [State Administration of Foreign Exchange] has authorized the same amount for the six authorized fund houses for QDII. However, since the first QDII fund from China Southern Asset Management was a big success, Safe might double the limit to $4 billion. And all other fund houses are trying to go for the new limit, ourselves included.
What are your plans for QDII?
QDII is extremely important for us. We want to bring in our international expertise to the Chinese market. Roughly, SG Asset Management is covering 99% of the global market capitalization. We are capable of introducing products invested in all the main markets in the world, even all the big emerging markets. We feel we can offer more in designs and we have to work quicker.
Gabriel Gondard, our deputy CIO, is in charge of QDII product development. After seven years at SGAM, he has been working in Fortune SGAM for two years. Another Chinese fund manager who has worked in the US for 10 years will run the team with Gabriel.
Our first product is ready. We have submitted our product to the CSRC for review. This is why I cannot give you any more details. But I can tell you it is not a fund of funds. It will be directly invested into foreign stock markets and we will have real key decision centre in China. And we use the direct advisory capability of SG Asset Management. But all the responsibility of the investments and all the decisions will be made in China. Everything else required û compliance, trading, clearing û will be done in Fortune SGAM. We are working on a product that will be directly invested in international stock markets. But it wonÆt be a global or worldwide allocation. It wonÆt be a copy of the Southern fund. ItÆs a completely different product.
SGAM is a major product provider for structured products in international markets. How is it reflected in your China joint venture?
It is a market situation and a regulatory issue. Although the SGAM Group is a big leader in guarantees and other alternatives products, we have never launched one in China so far. My analysis is very simple: because of market issues (lack of instruments and so on) it is difficult to launch a CPPI product in China which can deliver a real good performance. And we donÆt want to launch in China a product whose performance does not completely fulfil the expectation of Chinese investors. ItÆs a long-term view. If you sell a fund with bad performance to a distributor, youÆre jeopardizing future opportunities.
There are more financial institutions authorized to go into the QDII business in addition to banks and fund houses. There will also be insurance, trust, and securities firms. How do you see the landscape changing?
CSRC, our regulating authority, has signed memorandum of understanding with 35 countries so far which means in terms of product design, our scope is much more open than banksÆ QDII products, which are mostly using products that are registered in Hong Kong. We are in the same family in the financial industry. But we have completely different investment scope. Of course, I canÆt say the same for insurance and trust companies. Their QDII programs are completely new.
You donÆt speak Mandarin and you are French. Doing business in China is about building guanxi û the right access to those in power. How does that affect your business?
Language is not an issue. Simply do what you say and let people know you are serious. Our Chinese partners are very strong. They have a lot of connections for sure. I was in China with no relationship from the start. Here, you build trust and relationships over time by committing and delivering. I go to Beijing very often, for at least twice a month to meet with the regulators and partners. We have been working together for five years now. Sometimes there will be personnel changes. The officials have their own careers. But I keep visiting. They know if you are committed and if you are doing your job. ThatÆs all, but it works.
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