May 07, 2021 05:42 PM

Opinion: China’s Financial Opening Doesn’t Guarantee Success for Foreign Heavyweights

Over the past few years, China’s reform and opening of its financial sector has been gathering momentum, drawing in foreign capital and know-how in a bid for tighter coupling with the international financial system. Deal-making by global financial titans — whether to become majority stakeholders in their existing joint ventures, create new partnerships or submit applications to establish their own operations — continues apace.

Despite policy easing by Beijing to lower barriers to participate in the world’s second largest capital markets, heavy obstacles still remain for foreign firms operating in the unique business climate that is China. While aspirations remain high, lofty goals are more grounded in the reality that market expansion has been slower than anticipated and that even global investment managers with stellar reputations does not always translate into immediate success.

Gone are the days when overseas asset managers could enter China predicting that given time, their superior portfolio construction techniques and decades of experience would upend local rivals. Consider the institutional versus retail investor mix. In developed markets, institutional players rule the roost but in China retail masses drive market momentum. This singular dynamic, spins off countless nuances and shades of gray that color the market canvas in unexpected ways.

First, though the level of product knowledge and investment sophistication is still burgeoning, China is not an easy market to operate in. Active investment strategies overwhelmingly dominate. It is not uncommon to see hot money pursue star managers or advisors, reminiscent of the U.S. mutual fund industry in the 1980s, when fund vehicles came of age and star portfolio managers like Peter Lynch at Fidelity became household names. How hot is China? In 2020, $243 billion of equity funds were launched, a record year according to Z-Ben Advisors Ltd.

Retail investors wield substantial market firepower, leaving overseas managers scratching their heads as to how funds should best be marketed and sold in China. Local players are nimble, quick and eager to try unconventional business models and marketing techniques to attract fund flows. Over the past year, investors have turned to social media, setting up fan clubs that canonize celebrity managers, creating a multitude of followers led by adoring fans, amping up the emotional connection to the fund manager. The effusive adulation, reminiscent of a teen idol following in the U.S. has led some industry executives to dismiss the hype as “cheesy.” Cheesy or not, seizing the spotlight led to sizable fund inflows at local managers, like E Fund.

China’s fund industry is much newer than that in America or Europe and investors are notorious for jumping from one fund to another, chasing the hottest manager with the best performance returns. So how do local fund managers keep the retail masses engaged? By tapping into social media, livestreaming on investment platforms, educating their clients, becoming a digital influencer that jealously guards its flock. To remain competitive, global asset managers will need to bootstrap it and consider adopting non-traditional marketing and outreach methods. Why? China is different.

Fan adulation is one thing but earning investor loyalty is a long-term undertaking. In China’s volatile equities market, the former does not translate to the latter. Investors are fickle and can reverse course instantly. After record equity fund flows in 2020, the beginning of 2021 continued strong with 200 million yuan ($31 million) to 500 million yuan of fund inflows per month, which all but slowed to a drip in April. Investor love for funds crested in the first quarter this year and subsequently waned and fell out of favor, at least temporarily.

This brings us to Vanguard’s unexpected and surprising withdrawal for a mutual fund license. Months in the making, it provides a warning to other global managers keen on staking a claim in China. Two critical decisions underscore how difficult China’s market is even for a firm of Vanguard’s global brand recognition and stature. Last fall, the world’s second largest asset manager returned $21 billion to institutional clients on the Chinese mainland in order to concentrate on low-cost funds for the retail masses.

Institutional clients are especially demanding, requiring customized reporting, dashboard views of investment holdings, detailed transaction history, security level performance attribution — much of which can be automated. But requests for periodic access to portfolio management and research teams, unscheduled visits, added restrictions to the investment mandate and other ad-hoc needs — all high-touch demands raise the expense structure compared to a retail investor, making institutional clients more troublesome and less profitable. Last month Vanguard grabbed headlines yet again by mothballing its application for a mutual fund license, choosing instead to focus on its partnership with Ant Financial to sell a robo-adviser product that targets the vast retail market. Given the heightened regulatory scrutiny on Ant and other fintech companies, it remains to be seen how Fidelity’s partnership with Ant will be impacted over the long-term.

In addition, foreign managers must grapple with regulatory concerns of operating in a host country. China’s Cybersecurity Law makes it difficult for foreign offices to share data with an overseas parent company due to data localization rules. Other requirements not unique to China are part of the experience of doing business away from the home country and cannot be avoided.

China’s opening of its financial sector has created an unparalleled opportunity for foreign institutional players. But this requires a steadfast commitment and a long-term vision. Although Beijing’s policy easing has lowered barriers to entry, once in China, foreign fund managers still face considerable hurdles. Distribution and branding disadvantages, reluctance to dabble in unorthodox marketing methods, hesitancy to seize on emerging trends, plus the usual regulatory difficulties of operating in another country — make operating in China taxing but not impossible.

Joel A. Gallo is CEO of Columbia China League Business Advisory Co., a Guangzhou-based management consulting firm, and a former executive at Deloitte, E&Y, PwC, and EMC Corp.

The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.

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