Regulators Squeeze Portfolio Options for ‘Fund of Funds’ Investment Firms

(Beijing) — China’s new guidelines for “fund of funds” (FOF) investment firms have declared stock futures and government bonds off-limits, effectively ruling out the quantitative investment strategies some firms were planning to launch.

The new guidelines, covering domestic firms and issued April 24 by the China Securities and Exchange Commission (CSRC), fleshed out a September policy that barred FOFs from investing in funds whose stakes include financial derivative products.

FOFs, also known as multimanager investment platforms, are funds that hold stakes in basic investment funds rather than stocks and bonds.

CSRC’s latest ruling will have “significant impact” on FOF investment strategies, according to several fund-company employees familiar with the situation and who asked not to be named.

“We planned to launch a quant hedge fund but have had to drop that plan,” said one company’s risk control manager. Quant funds often use futures to hedge risk.

The guidelines also laid out standards that divide China’s FOFs into four categories based on whether assets are invested in stock funds, bond funds, money market funds, or a combination of the three.

The categorization step builds on the September policy, which defined an FOF as a fund that invests more than 80% of its assets in other investment funds.

“By requiring them to be categorized, the guidelines set out clear limits on the ratio of different assets an FOF can hold for the better of good governance,” the risk control manager said.

But the guidelines also set limits for FOFs. For example, FOF fund managers cannot invest in structured funds that have been divided into superior and subordinated tranches, as the latter are seen as exposed to more risk in the quest for higher returns.

FOFs are also barred from participating in a Mainland-Hong Kong mutual recognition-of-funds program launched in 2015. The program gives investors on both sides access to a few select funds.

But the guidelines give FOFs access to China’s Qualified Domestic Institutional Investor program, through which mainland funds can invest in offshore securities.

Contact reporter Wang Yuqian (yuqianwang@caixin.com)