April 2016 Z-Ben Advisors presents A Strategic Outlook 2016 China Rankings: In depth
Who is doing China the right way? Executive Summary An important step in improving anything is tracking progress your status now compared to five and ten years ago. Only after benchmarking yourself against your peers can you recognize, then address, areas of weakness. The Chinese financial services industry represents tremendous opportunity. However, regulatory barriers and nascent markets necessitate a multipronged approach that can be very difficult to evaluate. From our office in Shanghai, Z-Ben Advisors has closely followed how foreign asset managers have navigated the maze of programs and platforms required to access the mainland market. As laid out in the full rankings document, the intent of our 2016 China Rankings is to measure and qualify how foreign firms are performing in three business lines: inbound, outbound and onshore a commitment that can be measured by considering participation and ownership in a variety of programs and platforms. Any evaluation, we believe, must not only consider current market position but also how well a firm is placed for future growth. Our findings may not be surprising but they are revealing. China is a market where high barriers to entry favor top-tier firms, but regulatory resets also allow nimbler firms to capitalize on opportunities created by the duration mismatch between the speed at which China operates and the tortoise-like decision marking processes amongst global firms. 2
Recalibrating your approach At the moment, China decision-makers spend most of their day worrying how to sell China funds to global investors or how to get their global product on mainland distributors shelves. In the future, larger fund flows and revenue will accrue to global firms by managing Chinese assets in Chinese markets. Consider the inbound market comprised of QFII, RQFII and other inbound investment programs it was worth USD230bn in total AUM at the end of 2015. The mainland mutual fund market added more assets than that in a single quarter last year. Alternatively, consider outbound investment from Chinese investors. SWFs (CIC, SAFE, NCSSF) allocate more than USD350bn offshore in mandates a year, insurers and other institutional investors add another USD25bn, while HNW and retail investors bring the total to just under USD450bn flowing offshore to asset managers a year. That s less AUM than that of the (almost completely untapped) mainland public pension system. We strongly believe that China s pensions system, which will shortly begin entering domestic equity and bond markets, will create more management opportunities than any effort to drive greater volumes of institutional capital offshore. China s onshore business far surpasses inbound and outbound channels China market sizing by business type, USD bn (2010 2021e) Onshore 25,481 Mainland 11,486 1,205 Outbound 450 72 1,649 2021e 2015 2010 Inbound 201 1,996 2015 USD11,486bn Source: Z-Ben Advisors 20 0 5,000 10,000 25,000 15,000 3
The core of your strategy USD4bn Total estimated profit by the mainland mutual fund industry in 2015. 28% Average profit margin amongst mainland mutual fund managers in 2015. USD50m Aegon s share of the RMB660m profit earned in 2015 by its China JV, Aegon-Industrial. Source: Z-Ben Advisors In fact, the domestic market is not only larger than its cross-border cousins but even conservative estimates peg it as one of the world s fastest-growing. Its recent momentum public mutual fund AUM has increased 180% in just two years has not yet been augmented by two key drivers. First, pension flows from both private and public coffers remain small and reforms could soon open their floodgates. Second, the industry can expect additional disintermediation from banks but not necessarily from cash deposits. In the strictest sense, most asset management on the Mainland is accomplished through structured loan products, such as trust or bank wealth management products. But their high yields are declining and the corporate finance system is moving further away from bank dominance. As a result, asset managers mutual fund companies, private fund managers and online fund platforms are snatching up assets previously managed by the banks. Further erosion of structured products market share will lead to additional fund flows. Foreign managers which have ventured into the Mainland, whether through partnerships or wholly-owned entities, typically return with war stories of complexity and inaccessibility. Make no mistake: not only is asset management in China a high-growth industry, it s also extremely profitable. There have been a few high-profile exits, but the vast majority of JVs are in the black: Z-Ben Advisors estimates that 90% of the 44 FMC JVs were profitable in 2015. The domestic mutual fund industry as a whole averages 25-40% profit margins a year, thanks to fees higher than global averages. And, in our view, those fees aren t yet coming under meaningful pressure. 4
The strength of your commitment Most foreign managers acknowledge the rich potential of the mainland market. However, regulatory restrictions on the business activities of foreign financial services firms can hamper their ability to access the mainland market. Frustrations with the slow pace of regulatory reform can be justified but these frustrations should not distract from what is the ultimate prize. The 2016 China Rankings were designed to favor firms that have positioned themselves for success on the Mainland. We have little doubt that success will largely be determined by a manager s ability to sell Chinese funds to Chinese investors. While global firms should continue to focus on the inbound and outbound markets, as they will maintain a competitive advantage over domestic firms in each, success in these markets is already becoming reliant on a strong domestic presence. The recent opening of the interbank bond market to foreign investors and the low level of RMB exposure in North American and European institutional investors portfolios will surely open opportunities for inboundfocused managers. But no China fixed-income manager (foreign or domestic) is strongly positioned to capture these flows. We lack a PIMCO. The increasing complexity of Chinese financial markets, coupled with maturing mainland competitors, will require a stronger onshore commitment even for those foreign firms just hoping to stay competitive for inbound flows. Likewise, the fly-in, fly-out model that has served foreign managers solely interested in Chinese institutional mandates is nearing an end. This isn t 2007. A mandate from CIC no longer qualifies as a China strategy. And continuously shrinking fees from SWFs may require a downgrade to economy for the quarterly flights. If institutional money remains a priority, insurers should be the focus, but they require significantly more handholding and are not all located on Jinrongjie. Over the last two years, several firms including BNP Paribas, UBS, and Rothschild have set up wholly-owned entities onshore precisely to build relationships with insurers, especially those outside of the industry top ten. Regulators use expanded access to tame volatility Notable regulatory and competitive events in 2015 March 2015 Foreign ownership restrictions on trusts lifted. September 2015 Hang Seng registers 70%-owned JV FMC. November 2015 HSBC announces 51%- owned JV brokerage. February 2016 SAFE reforms the QFII inbound channel, offering quota proportional to AUM. September 2015 Aberdeen AM receives approval for first investment management WFOE. October 2015 Fidelity applies for an investment management WFOE. February 2016 PBoC announces that foreign managers can have quota-less access to the domestic interbank bond market. Source: Z-Ben Advisors 5
JV FMCs: The old fashioned Our advice to foreign shareholders has remained the same for ten years: concentrate on areas where a foreign party can provide value. The traditional mainland joint venture has made a comeback of sorts. Long derided as nothing more than jet lag and a headache four times a year, the advent of Mutual Recognition of Funds (MRF) and a near-doubling of industry AUM in 2015 have been a reminder that the JV obituaries may have been premature. The uphill battle to China access, however, does lead to divergent approaches. There s a wide spectrum of foreign party involvement across the 44 JV FMCs, from just cashing the dividend checks to effective parity of control. Our advice to foreign shareholders has remained the same for ten years: concentrate on areas where a foreign party can provide value. For some firms, this means focusing solely on the crossborder market with a hands-off approach on domestic affairs. Here, Deutsche AM (#9 overall) is a good example. Its JV, Harvest, has been extremely successful for a number of years precisely because its FMC s internal management has significant control over the mainland strategy. But Deutsche AM has been very helpful on all cross-border initiatives: selling their Hong Kong business to Harvest, sub-advising on QDII funds and partnering to offer jointly-branded ETF products in the US. The least JV JV on the Mainland is probably Invesco (#4 overall), which likely has the most say of any foreign firm in its JV. It owns 49% of Invesco Great Wall exactly the same as the largest mainland shareholder, Great Wall Securities. Invesco has poured resources and international best-practice thinking into the firm, giving it a valuable set of contacts and experiences on the Mainland. Of note in what should be a lesson to other Chinese shareholders the partnership has bred success. Invesco Great Wall is one of the top FMCs on the Mainland, with competencies in fixed-income, QDII, traditional equity and even MMFs. That reputation isn t a secret to buyers. 6
Not all assets are created equal Control both legal and practical in a mainland entity was a large determinant in the rankings because it can both develop a firm s China team and give headquarters a strong degree of comfort to make quick decisions in China s fast-moving regulatory environment. Another major rankings component was the health of a manager s joint venture. When non-core and subsidiary assets are included, the mutual fund industry ended 2015 with RMB21tr in AUM (USD3.2tr). It was just RMB5.1tr two years ago. Some of this growth was due to inflows during the equity boom, but most of the nearly USD2tr in new assets added arrived in money market funds and low-fee product packaging. Foreign managers which own a stake in a JV with a high percentage of equity assets scored higher, not only because they generate higher fees and better margins, but also because assets in equity and balanced products are more likely to be sticky. Many FMCs have padded their earnings through the online MMF boom or by packaging products for the channel business (shadow banking, in headline form) but, moving forward, more diversified offerings will be needed. Principal Global Investors shows up lower on our list precisely because of this. Its JV mutual fund company, CCB-Principal, enjoyed the eighth-highest AUM at end- 2015 with over RMB315bn (USD48bn). Not only does Principal only hold a 25% stake, more than three-quarters of the JV s assets sit in one money market fund. Worse, the firm typically sees large inflows at year-end followed by large outflows immediately after Chinese New Year. Still, Principal likely views its JV as only a means to the ultimate prize: tapping the Chinese pension space. It should move up next year in our rankings as it announced a pension partnership with CCB in March and established a new WFOE entity in Beijing in February. One step back, two steps forward. Global firm China JV Stake % Ex-MMF AUM (RMB bn) Equity % of AUM Z-Ben onshore rank Amundi ABC-CA 33% 22.3 18% 46 Principal CCB Principal 25% 76.0 10% 53 Credit Suisse ICBC-CS 20% 199.3 20% 32 BlackRock BOC 17% 97.3 13% 26 JPMorgan China International 49% 46.7 38% 1 UBS UBS SDIC 49% 65.8 42% 2 Invesco Invesco Great Wall 49% 51.3 54% 3 Source: Z-Ben Advisors Eurizon Penghua 49% 110.7 56% 4 7
Having it all 2015 EOY GC AUM: USD3.33bn JV Brokerage: JPM First Capital Securities JV Trust: Bridge Trust JV Brokerage: UBS Securities UBS JV FMC: UBS SDIC 2015 EOY QFII quota: USD1.5bn JPM JV FMC: China International 2015 EOY QFII quota: USD1.7bn WFOEs: One QDLP WFOE, one PE/VC WFOE 2015 EOY RQFII quota: RMB2.5bn WFOEs: Two securities WFOEs, one PE/VC WFOE 2015 EOY GC AUM: USD5.2bn 2015 EOY RQFII quota: RMB3bn Source: Z-Ben Advisors Unsurprisingly, the top two firms on our list, JPMorgan (#1) and UBS (#2), have developed the most extensive mainland presences. Both of these firms set up WFOEs early and are well-positioned to capture future growth. They also enjoy immediate access to the mainland market through a strong JV FMC and other onshore entities. In addition to its FMC, UBS also has one of the largest JV brokerages. This provides additional opportunities for its investment arm, but also gives UBS essentially two asset management platforms on the Mainland. With securities firms managing RMB11tr in assets at the end of 2015, this advantage is both meaningful to China profitability and very expensive to duplicate. JPMorgan, meanwhile, boasts three asset management arms, with a JV brokerage and JV trust to go with its JV fund management company. Like Invesco, JPMorgan exerts significant sway over its JV FMC, China International, despite its 49% ownership. China International is one of the most diversified mutual fund companies on the Mainland. It adapted well to the money market fund boom, while also maintaining a strong equity team, allowing it to continue to grow in 2015. Most important, however, is the support JPMorgan has given to China International s cross-border business. It s now reciprocal, with China International providing support to JPMorgan s mutual recognition plans. 8
Outbound: Banking on it Of the three markets, outbound investment is the primary focus of the majority of foreign firms in China. Without doubt, an institutional mandate is a great, low-cost way to get your feet wet on the Mainland and has remained the best target for many firms over the past ten years. But the institutional approach has a ceiling and, given the growth outlook for asset management globally, to Z-Ben Advisors, there isn t a better market to invest in retail fund flows than China granted, we re a little biased. The hunt for outbound institutional investors has already begun to move away from the SWFs. Schroders comes in at #1 on our outbound rankings due to its rich experience across almost all outbound investment programs selling to institutional, retail and HNW clients. Their success is rooted in deep partnerships with banks on the Mainland. It serves as subadvisor on two QDII funds for BOCOM Schroders, its JV FMC with the Bank of Communications. It has also been aggressive in exploiting bank QDII, with nearly 30 products on bank shelves in the Mainland, all at foreign banks which have been the primary users of the bank QDII channel. In truth, Schroders can claim much of the credit for discovering those foreign banks unrecognized selling strength. These diverse experiences with onshore distributors bode well for Schroders as it moves forward with its mutual recognition plans, while its newly-established investment advisory WFOE should ensure that it s positioned to capture more institutional and HNWI assets in future. Given the growth outlook for asset management globally, to Z-Ben Advisors, there isn t a better market to invest in retail fund flows than China granted, we re a little biased. 9
Inbound: Seeking out demand Samsung ranks #1 in our 2016 inbound rankings, which may be surprising but, in our view, is nothing more than a preview of the firm s growing ambitions in China. While developed market investors have been skeptical of China, South Korea has been one of the few bright spots, with RMB68bn in RQFII quota given out to asset managers and insurers in 2015 alone. Samsung has also been the most aggressive firm in building out its RQFII business with quota issued to four separate entities. Mirae Asset has also been active, winning RQFII quota awards from both South Korea and Hong Kong. Samsung has already delivered strong results, nearly doubling its Greater China AUM in 2015 while building out its ETF suite in Asia. The recently announced QFII and interbank bond market liberalization may diminish the importance of its RQFII awards but the scramble for outbound quota over the past year should be a reminder that firms cannot wait to act until demand materializes. BNP Paribas came in at #4 in the inbound rankings. It has also built out a multi-hub RQFII strategy with quota in its home market in France, a license in Hong Kong and an extra RMB8bn in Korean RQFII quota through its JV Shinhan BNP Paribas AM. While the inbound market will grow alongside the outbound and mainland markets, it is also where global managers will need to learn to play defense. Chinese managers are slowly becoming more familiar with global practices, and foreign investors may come to prefer local managers aggressive approach to local markets. In Z-Ben Advisors firmly-held view, fixed income markets will provide the arena for heated competition between global and Chinese managers. Global investors are likely to move faster on RMB credit than on equities, given tasty running yields, recent expansion of interbank bond market access, IMF SDR inclusion and persistent footdragging from equity index providers. Bonds have always been the favored investment of conservative investors making initial approaches to emerging markets. China will be no different. To compete effectively against global bond managers, Chinese managers still need to build out their often underdeveloped fixed-income teams, in addition to some much-needed compliance and servicing upgrades. Unfortunately, there s only so much managers domestic or foreign can do at the moment as the credit market s immaturity is holding back price discovery. However, that is also precisely why now is the time for global managers to develop real China debt teams. Loose monetary policy and an inefficient market, combined with municipal bond and asset-backed securities expansion programs, are creating real investment opportunities in the short-term. At least as importantly, using this entry point to create a China fixed income track record will give some global firms the credibility and experience to attract more assets in the medium term. 10
American muscle Fidelity, BlackRock and Vanguard top the global asset management space and have taken markedly different approaches to China. Given their popularity with global investors, it s no wonder that all three score well on the inbound rankings with BlackRock at #3, Fidelity at #6 and Vanguard just missing the top ten at #11. BlackRock s inbound business is largely dictated by its A50 ETF, which was one of the easiest and most popular ways to gain China exposure for many years. BlackRock has scrambled to obtain additional access to compete with RQFII ETFs from mainland subsidiaries. Vanguard and Fidelity, meanwhile, shared a similar approach, despite (largely) working opposite sides of the active/passive divide. Fidelity expanded its China access in 2015, receiving USD800m in additional QFII quota, the largestever single award for an asset manager. Vanguard, for its part, was awarded what was then the largest-ever single RQFII quota with RMB10bn out of Australia. It broke this record, receiving another RMB20bn in RQFII quota in January of this year, which is not included in the rankings. That s where Vanguard s China attack ends. Over the next five years, it will likely concentrate on building out its inbound business. Of the three US groups, it has been the most vocally receptive to equity index inclusion. Perhaps it plans to raise funds from Chinese investors but it is five years away from developing a meaningful domestic business, assuming no acquisition gives it a foothold. That may not be a bad strategy. Z-Ben s rankings are designed to give a status report but do not factor in investments made. BlackRock has made large investments across all three business lines. While it has found success across all areas, especially on the outbound side, it has required significant resources, and BlackRock s mainland future is muddled by its 17% stake in FMC BoC. Like Vanguard, Fidelity declines to operate a JV with minority control. The JV s utility has long been the subject of contentious debate on the Mainland, but we may be at an inflection point in the argument. Fidelity s experience in Japan offers a lesson. It sat on the sidelines for years until it could wrestle full control in the late 1990s. Almost 20 years on, it has built a thriving Japan business. With Fidelity s recent QFII quota increase and the establishment of its 100% foreign-owned investment management Shanghai entity in October, the Fidelity way may finally be coming to the Mainland. While the JV may not be resurgent, it is surely not the only game in town. Total score by market Mainland Onshore BlackRock Average score by market Mainland Onshore Fidelity Vanguard Inbound Outbound Inbound Outbound Source: Z-Ben Advisors 11
A U T H O R S Chris Powers Manager, Consulting chris.powers@z-ben.com Mr. Powers covers the Chinese financial services industry, specializing in domestic asset managers and internet finance. He advises clients on strategy, execution, valuation and due diligence services on the Mainland. He recently completed a market assessment and positioning analysis of the mainland private fund market for a North American hedge fund. He also aided a major European financial institution in establishing its mainland operations. Other projects include due diligence on a Chinese brokerage for a British asset manager and identifying Chinese buyers for a Russian asset manager. Mr. Powers also leads the firm s analytical and advisory efforts in the burgeoning internet finance industry, helping clients to develop distribution and product strategies to capitalize on recent growth in online finance. Prior to joining Z-Ben Advisors, he worked at ZPMC, a Chinese state-owned-entity based in Shanghai. He then worked as a consultant for Waypointe, a supply chain consulting company based in Shanghai. Mr. Powers has an A.B. from the University of Chicago with a double concentration in History and Philosophy. Neil Flynn Analyst neil.flynn@z-ben.com Mr. Flynn covers the Greater China investment management industry, specializing in global asset management and capital markets. He leads the research and deliverable production of Z-Ben Advisors Greater China Quarterly for clients as well as the annual investment manager rankings report. He also regularly produces reports on fixed income, cross-border investment and alternative assets. Prior to joining Z-Ben Advisors, he worked as a derivatives trader for a global macro hedge fund in London. Mr. Flynn holds an MSc in finance from the University of York. A B O U T Z - B E N A D V I S O R S Z-Ben Advisors is a Shanghai-based consulting firm that helps global financial institutions capitalize on the fast-growing business opportunities presented by the Chinese and Greater China markets. Our business foundation is bottomup, on the ground research; our services translate that research into actionable intelligence, recommendations and advice. The firm has permanent presences in Hong Kong and New York, with the majority of its staff based on the ground in Shanghai. 12
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