China lacks benchmarks because it lacks indices. “New funds require innovation,” says Zhao. “The current 33 closed-end funds are all fairly similar.”
Currently, most funds are ‘balanced’ funds, meaning they invest across sectors (not ‘balanced’ in the international sense, as every mutual fund in China must have at least 20% of its NAV in government bonds) or are indexed against an exchange. The development of growth, value, small-cap and other strategies has yet to take off in a meaningful way.
Ask Chinese fund management companies about performance and they will all claim their funds are top performers. Well, they can’t all be, but there is no methodical way to compare risk-adjusted performance among different strategies. The only two widely accepted indices are those for the Shanghai and Shenzhen stock markets.
“Right now it is really hard to compare investment styles,” laments Allan Wang, assistant CEO at Huaan in Shanghai. “We cannot create new types of funds without indices.”
Other indices do exist. Several securities companies such as CITIC Securities, as well as the recent joint venture between Xinhua Financial News and FTSE, are promoting indices. But most fund managers say these are not popular because they are not published except in financial newspapers or on the sponsor’s website. Furthermore, investors often do not understand the importance of indices, complain fund managers.
Huaan’s Wang says: “A benchmark must be publicized and recognized. New ones take time for the market to accept.” As it stands, he is not satisfied with the existing exchange indices. For example, the Shanghai Stock Exchange index includes B shares, which local fund managers cannot touch. The recent rally has inflated the B-share component of the index, creating problems for local fund managers.
Help may be on the way. CSRC, at the behest of its senior advisor Anthony Neoh, is pushing the two stock exchanges to launch a joint all-China stock index, a move fund managers support.
The Shanghai Stock Exchange is said to be enthusiastic about the idea. Shenzhen’s bourse is said to be not exactly resisting, but not making it a priority. Right now, Shenzhen is battling just to stay alive, as Shanghai’s power as a financial centre grows. It has been nearly a year since a company listed in Shenzhen. Also, the Shenzhen authorities are preoccupied with establishing a second board to attract high-tech companies.
The other lure for having indices is to launch exchange-traded funds (ETFs) – baskets of index component stocks that trade on an exchange like a security. The government is exploring ways to use ETFs to sell off shares in state-owned enterprises, mirroring Hong Kong’s divestment of stocks into the Tracker Fund in 1998. Fund managers are also keen to learn more about ETFs to add to their product stables, and the exchanges themselves want to promote ETFs as they lose their close-end mutual fund business.
ETFs remain a long-term vision, however. A major structural issue is that ETF baskets are created in-kind, not in cash. State-owned shares cannot be contributed and redeemed, so as long as listed companies are SOEs, they can’t be replicated in an ETF. Furthermore, there are no futures or options or other hedging devices available in China. An ETF requires index futures to work.
In the meantime, Harvest is taking the initiative and developing its own index for value funds. (Boshi also has developed proprietary indices.) “We want to publish ours in a few months,” says Zhao. The main target will be potential institutional customers because dissemination without help from a stock exchange will be limited. But Harvest would like to find a third party – a domestic version of MSCI, FTSE or Standard & Poor’s – that could promote indices, whether Harvest’s own or others. “China needs indices to develop its mutual fund industry,” he says.
