China’s Mutual Fund Difference

Tony Zhang, winner of Morningstar’s China Equity Fund of the Year Award in 2013, opens up about the industry’s rocky start in China — and why its troubles may be a thing of the past.
Mary Wadsworth Darby |  February 24, 2014
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In 2001, when China acceded to the World Trade Organization, its mutual fund industry was recovering from a decade of mismanagement and scandal. Self-dealing, insider trading, and front running had been rampant before the government stepped in to “restart” or close some funds, merge or recapitalize others, and force out many senior managers. With investor confidence shattered, total assets under management (AUM) were an almost microscopic US$200 million There were no bond funds, no money market funds, and only a handful of mostly closed-end funds.

Today, the Chinese mutual fund industry has AUM of approximately US$500 billion, with an array of investment products and extensive regulation. Recently, Chazen Professional Fellow Mary Wadsworth Darby recently sat down with Tony Zhang, chairman of the Shanghai-based Franklin Templeton Sealand Fund (FTS) to discuss the industry’s past and future.

Mary Wadsworth Darby: What are Chinese investors looking for in a mutual fund?

Tony Zhang: Investors here are looking for high returns with a short time horizon — normally one year. However, if the investment sinks deeply in the red, they usually choose to stay long and wait for recovery. It is not costly to move from fund to fund. The redemption fee does not deter people.

Our goal is to create sustainable long-term performance, but this concept is not well understood by a typical retail investor.

MWD: Why not?

TZ: Our primary competition isn’t other mutual funds — it’s real estate. High-net-worth and retail investors traditionally have not put much of their wealth into mutual funds. The Chinese investor buys a house for retirement and then hopes to buy a second for rental income. The average Chinese investor has not had a good return investing in stocks. And volatility is too high. So people today are reluctant to put money in equity markets. Less than 10 percent of people’s wealth is placed in mutual funds.

“We look for people who want to convert a portion of their savings from commercial bank deposits. We have to compete with something called a “wealth management product” — a deposit-based product sold through commercial banks, which offers better returns than a straight bank deposit.”

MWD: You joined Franklin Templeton in 2004, a time of tremendous turmoil in the industry. The government cleanup had started, and the industry was still very small. What was your biggest challenge?

TZ: The industry’s image was still bad. It was difficult to hire people and to start from ground zero.

Our strategy for the first portfolio was to launch a China Income Fund. Nothing like it was available in China. Our team had no track record, so we had to sell the Franklin Templeton (FT) name, but this was not as easy as you might think — the name was not well known to retail investors in China. It helped a lot that FT put in seed capital US$10 million with this first fund.

The other big challenge was getting the team in place. Quality fund-management infrastructure did not exist. We had to create it in China. One analyst left after just two weeks on the job — he quit. I ended up doing a lot of research myself.

MWD: How did you market your first fund?

TZ: We sold it through the Industrial and Commercial Bank of China [ICBC], the largest commercial bank in China. ICBC was both the distributor and custodian. Retail money came from its existing depositors. That was not easy. Retail investors had no idea about us and FT.

MWD: What happened after you launched that first fund?

TZ: The first fund, a balanced fund, had an equity limit of 60 percent. The fund lagged behind equity funds from competing firms, and shortly after the launch, the stock market had a strong rally. The fund investors were upset. They did not distinguish a balanced fund from an equity fund. They just wanted good returns.

After learning that lesson, we launched a second fund, an equity fund.

MWD: How did you get over that rocky start?

TZ: Fortunately, the second fund, Franklin Templeton Sealand Flexible Market Capitalization Fund, really took off. It has good long-term performance. It got me Morningstar’s China Equity Fund of the Year Award in early in 2013.

MWD: What advice would you give to someone who wants to enter the mutual fund business in China?

TZ: Do not just read research report, pay an onsite visit. Some listed companies may not provide complete disclosure as they should. When you buy a stock and hold on to it, the stock price could be volatile. Sometimes, a stock’s price goes up 2 percent one day and down 2 percent the next day. However, in a fast-growing economy like China, holding onto a good company could return very well over time.

MWD: What’s the future of mutual funds in China?

The future is certainly bright. There are more and more quality companies available to invest, be it in healthcare, media, IT, or consumer products. There are about 2,500 listed companies in China’s stock market. I only need to pick 30 stocks. I have a concentrated portfolio.

Under the new Chinese leadership, the state sector is going to conduct comprehensive restructuring, forcing companies to be profit-driven and shareholder oriented. I am very much encouraged by that.

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