| HONG KONG, June 9
HONG KONG, June 9 Contrary to trends in the
West, actively managed stock funds in China are set to become
more popular with foreign investors, as moves to open up Chinese
markets should give stock pickers an edge over poor performing
Looking for a way into the world's second biggest economy,
but intimidated by capital controls and strict investment
quotas, investors have been piling billions of dollars into
index trackers like synthetic exchange traded funds (ETF) that
use derivatives to bet on mainland shares.
As access becomes easier thanks to reforms, including higher
investment quotas and initiatives taken between the Shanghai and
Hong Kong bourses to ease investment on each other's exchanges,
that is about to change.
"As Chinese onshore equity markets open up to foreign
investors, index tracking funds or ETFs on onshore Chinese
equities may lose some favour," said Jackie Choy, ETF strategist
for fund tracker Morningstar Asia.
Globally, ETFs have grown to manage over $2 trillion as a
majority of actively managed funds in the mature Western markets
are failing to beat their benchmarks. Seven of every ten equity
funds investing in the U.S. equities have lagged the total gains
in the S&P 500 index over the last five years, Lipper data
Emerging markets actively managed funds, however, can
exploit market inefficiencies.
China, however, because of the constraints on foreign
investment, is the only 'big four' emerging market, or BRIC,
that has an index tracker as its biggest equity fund.
About $30 billion or 40 percent of the money managed by
China offshore equity funds is invested in index trackers. By
comparison, only about 17 percent of assets under management of
offshore India equity funds goes into index trackers.
Yet, many investors lost money using China index trackers
despite years of economic boom producing some of the world's
fastest growing companies.
While the MSCI China Index has fallen 40 percent since its
launch in 1992, China's nominal GDP has surged 19 times during
the period, according to Datastream.
Though cheaper and easier to invest in, ETFs are missing out
on returns that actively managed funds are able to generate
through stock selection and avoiding companies destined to fail.
Moreover, an index tracker raises exposure to China's
banking sector, which is otherwise being shunned by investors
due to mounting debt problems. The financial sector in the MSCI
China index, for example, has a 36.6 percent weighting.
"Stock picking in China is important," said Anthony Tse,
chief executive of Hong Kong-based hedge fund Pangu Capital.
"There are more investment landmines and frauds (in China),
which you don't see as much in developed markets," said Tse,
whose hedge fund has gained 19 percent since its launch on March
1 last year. During the same period the MSCI China Index rose a
measly 0.9 percent.
In a sign of the changing taste in favour of actively
managed funds, China focused hedge funds, that charge 2 percent
management fee and 20 percent performance fee, hit record assets
of $11.3 billion in April this year, data from Eurekahedge
Reforms should give managed funds more room to make money,
and attract investors, even if their fees are almost double
those charged by index trackers, industry experts said.
China is raising investment quotas for foreigners and giving
them more access to the mainland market through initiatives like
the Shanghai-Hong Kong Stock Connect system, due to be
introduced later this year, which will allow stock trading
between the two cities.
Regulators in Hong Kong and China have also agreed mutual
recognition of funds, in a move that will allow those funds to
be sold in each others markets.
Even operating under restrictions, China offshore actively
managed funds have returned 33 percent on an average in five
years to end of April.
The biggest one, $5.2 billion First State China Growth Fund,
has gained 108 percent, data from fund tracker Lipper shows.
By comparison, index tracking China offshore funds as a
group have gained 21 percent, while the widely followed
benchmark by foreign investors, MSCI China Index, has
risen 26.6 percent during the period.
Index trackers by design are not expected to outperform
benchmarks but should closely follow the returns from them.
Six in every ten China offshore active funds have bettered
the MSCI China's gain over the last five years, Lipper data
(Editing by Simon Cameron-Moore)