China Investment Management | Market Update

March 2012

Horseshoes & Hand Grenades

Table of Contents
Sector Assessments Executive Summary Shanghai 2015
Establishing a Financial Powerhouse

5 16 23

We would like to direct your attention to the recent, and rather consistent, rally in the Mainlands equities market. For some unfathomable reason, and regardless of the relatively steady move higher over the past eight weeks, there seems to have been little mention of the markets performance. Global headlines remain fixated on the debate over whether the Chinese economy will glide gently back to earth or come crashing down. If the stock market really is the leading indicator of economic activity we imagine it to be, Chinas investors appear to have made their decision. But we arent here to pontificate on the wonder that is capital appreciation (especially given the fact that the benchmark CSI 300 remains well below even the highs set in 2011, not to mention the record high). Instead, we ask: if there is a material reassessment of risk underway by investors, as reflected in the recent rally in equities, who will win and lose by it? It matters enormously whether investors are in the process of reapplying risk: nothing attracts assets faster in China than a rising stock market, and it attracts them by draining other pools of capital. Over the past two years, success in terms of gathering and retaining assets has been achieved almost exclusively by those financial institutions which provided investors with products and solutions having a clear fixed income (low-risk) bias. A very sound practice over the past two years, but we cant help but wonder if low-risk products have inadvertently created high-risk business practices. What if conventional wisdom about Chinese investors risk appetite is wrong? What if markets are pointing to an improvement in overall conditions, an improvement that itself convinces a growing number of investors to be more tolerant of risk? There are a lot of ifs in those last statements, but even a modicum of change in investor behavior could have disastrous effects for the very long list of financial institutions that have come to rely on an outsized pool of risk-avoiding capital in China. Take the commercial banking industry as a perfect example. Over the past year, the primary focus throughout the investment management space has been the aggressive promotion of wealth management products created by banks. We feel it necessary to bracket the term in quotes, as these products are really nothing more than ultra-short-term, yield-enhancing substitutes for bank savings. But with all of the forces at play throughout 2011, these bank-offered products werent so much the perfect option for investors as they were pretty much the only option. If investors are now reassessing their appetite for risk, then banks should plan for rough sledding. History helps to explain why. In early 2006, there was a similar reassessment of risk by investors, after a year spent piling into money market funds (the only alternative to bank savings at the time). With the equities market showing renewed signs of life, investors decided to

Private Equity
Postcard Lottery

26

Pension System
Reload With a Mandate

29

Trust Industry Review

The Trust Company With the Bank Tattoo

32

Market Entry
Private Fund Manager FXX

35

Insurance Intermediaries
The Next Distribution Channel

38

Segregated Accounts
8 Steps to Winning Your 1st RMB8bn in AUM

41

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For more information please contact: Francois Guilloux Director, Regional Sales Direct Tel: (+86 21) 3857-1323 francois_guilloux@z-ben.com

China Investment Management|Market Update

March 2012

exit from money market funds en masse, with redemptions totaling RMB120bn (USD20bn) over a single three-month period. At the time, that sum represented a full quarter of fund industry AUM and the proceeds RMB for RMB were redirected into equity mutual funds. By no means are we suggesting that the estimated RMB1+tr of assets (probably even more in reality) currently allocated into banks wealth management products will end up being fully disintermediated into something other than fixed income alternatives. That said, another sudden re-risking move wouldnt surprise us: wealth management products typically come with three-month terms, and their popularity has taught investors to make decisions based on the next quarters likely return. Thats a precursor for fast reallocations if weve ever seen one. Regardless of the size or speed of a re-risking move, it remains sound advice for the banks to expect a certain level of real disintermediation and plan accordingly for just such an eventuality. Fund managers shouldnt count on an easy ride either. Theoretically, rising equity prices should lead to an overall rise in industry AUM. We say theoretically because the vast majority of portfolio managers began 2012 with their eyes on the rear-view mirror and dramatic underweights in equities in the majority of their funds. That choice has already had an unpleasant impact: performance data for the first two months of this year shows that nearly every active equity fund underperformed the CSI 300, most by a significant margin. Worse, the fund industrys competitive dynamics will be further distorted by outflows from money market funds. Irrespective of market conditions, the first quarter of the year is always characterized by a sharp reduction in money market assets as temporary investments (in support of year-end market share rankings) are unwound. If the appetite for risk really is on the rise, then outflows could be far more pronounced than anyone expects. There were, of course, a small handful of notable exceptions. Fund managers who have demonstrated an ability to deliver strong returns so far this year could quickly encounter an unexpected windfall of new net flows. However, these are only occasionally the same firms which stand to lose large volumes of money market AUM. If we experience either a quick re-risking or a larger one that equity fund managers fail to catch in time, expect to see the AUM league table roiled. And, if you werent around to witness the 2006-2008s fun in person, remember this: one of the key determinants of market position at the end of a Chinese market rally is the proportion of AUM held in equity funds at its start. Fortune rewards the lucky just as thoroughly as it does the skilled. While banks and fund managers are the most obvious players in a re-risking drama, theyre certainly not alone on the stage. Continued momentum in the stock market could have a serious and negative knock-on effect for the rapidly expanding local private equity market, the only credible alternative to equities for higher-than-FI yields. While admittedly a cynical view, theres some merit in the argument that recent demand for PE products has had more to do with scarcity of investment options than with PEs intrinsic merits in China. Making matters worse, there is growing evidence that private equity funds raised over the past six to eight months have been largely sitting on cash, given challenges in finding viable targets. Few events will test PE investors patience more sorely than sitting on the sidelines of an equity rally. Z-Ben Advisors is emphatically not calling a bottom, sounding a charge or predicting a market regime change. Thats not what we do. We are pointing out how badly-positioned many managers of all stripes are for re-risking while noting the sudden appearance of evidence that re-risking might already be taking place. For us, thats enough grist for the analytical mills to start turning. In this case, the result of our analysis suggests that small fits and starts in the equity market deserve closer -than-usual attention. There is an enormous volume of cash and near-cash washing around Chinas financial system at the moment, much of it thinking on three-month return horizons. Dialogue about stock performance is, for the first time in years, centering on earnings expectations rather than macro issues. Stock picking skill is, also for the first time in years, able to be exploited and equity fund returns are becoming more differentiated as a result. Contrarian indicators such as defensive fund launches and no-yield/capital preservation products are looking long in the tooth. On top of all that, Chinas government and regulators would be delighted to see a market rally drive speculative capital out of the shadier corners of the debt and property markets. Their support for stocks, from nudges to SOE dividend policy through taxation issues, appears more likely than in recent years. Its not necessarily 2006 all over again. That said, conditions arent hugely different

Solid stock market performance may be an indication of investors renewed willingness to assume greater risk. And if true, there will be competitive consequences

Any material reassessment of risk by investors would have the most significant impact on the banks wealth management products

Fund managers will also be impacted by re-risking with those firms having a bias towards fixed income products projected to lose considerable market share

China Investment Management|Market Update

March 2012