Why hedge funds aren’t hungry for China WFOEs
Large traditional asset managers may be busy launching the first onshore China private funds out of their new mainland branches — Aberdeen Standard, BlackRock and Schroders have done so in the last month — but most hedge funds appear in no hurry to make similar moves.
The reasons for that are manifold and reflect the high barriers to entry, niggling legal risks, and strong competition from fund managers better known by mainland clients.
Of the 25-plus asset managers to have set up wholly foreign-owned entities (WFOEs) in China and to run strategies there, only Bridgewater Associates, Man Group and Winton Capital are hedge fund-focused firms. Indeed, close to half (43%) of Man's assets are in long-only strategies.
“We’re not seeing a rush [of foreign hedge funds] to go in there,” Carlyon Knight-Evans, Asia-Pacific alternatives leader at consultancy PwC, told AsianInvestor.
HEDGIE OBSTACLES
There are hurdles to overcome too.
"Going into China is challenging for hedge funds”, Knight-Evans said. “They’re not as welcome there as the large traditional players. So it’s always going to take longer [for them to get in] and what you can do in China is going to be constrained."
Moreover, setting up onshore is likely to be expensive, could take longer than managers anticipate and could yet fall short of target, Knight-Evans added.
And with good reason, given the fierce competition for China talent now fermenting among both asset managers and asset owners, which is why the bigger, better-resourced hedge fund groups are leading the way.
Bridgewater, Man and Winton each have $160 billion, $113 billion and $30 billion in assets under management (AUM), respectively.
Vasilopoulos agrees and breaks it down further.
Firstly, there are strict WFOE qualifying criteria that smaller managers generally struggle to meet.
Secondly, because of the extra costs involved in a jurisdiction such as China, smaller firms often lack the infrastructure and scale necessary to make it a viable option.
Thirdly, there remain serious unresolved legal and tax risks, not least of which is China's new cybersecurity law, which came into force on June 1, 2017. It obscures the question of which data can and cannot be moved out of the country without formal approval.
There are also still question marks over the protection of intellectual property rights in China, Vasilopoulos added, and the risk of arbitrary government action and market intervention is high, especially in volatile markets.
BRAND BUILDING
Another key issue is branding. Foreign hedge funds are simply not well known in China, as a general rule, Vasilopoulos said, and it takes many years to build strong brand recognition.
Why? The domestic hedge fund market remains in its infancy, and most investors — including institutions — in China do not understand the hedge fund sector.
The return profile of some larger retail fund managers in China can appear more compelling than that of even the most successful foreign hedge fund managers, rendering it very difficult for new market entrants to compete, noted Vasilopoulos.
And then there is the challenge of distribution, which is typically dominated by a small universe of established players, she said. These institutions typically promote third-party products at a significant premium, which again challenges the economic basis for developing a hedge fund platform in China.
Ultimately, the holy grail for traditional asset managers is to gain access to China’s mass-retail market. But hedge funds are not generally targeting the man or woman on the street; they tend to be raising offshore capital.
Meanwhile, the private fund launch pipeline continues to flow from traditional managers in China.
BlackRock said last week (on June 7) that it had registered its first onshore China fund, while Aberdeen and Schroders announced their own launches on May 17 and May 6, respectively. The first firms to launch onshore China funds were Fidelity, in May last year, and UBS Asset Management in November.
Firms must launch products within six months of receiving a private fund management licence. They can only obtain that after they have won approval to set up a WFOE, and products created under PFM licences can only be sold to wealthy or institutional clients.
This article has been updated to clarify that Man Group is not purely a hedge fund manager.