Chinese Mutual Funds (Part 1)

By Colin (Huaizhi) Chen

In the United States, actively managed mutual funds have long lost their glister. Contributing to their demise have been their hefty annual and initial management fees, their inflexible regulatory obligations, and the various financial studies concluding that mutual funds generally do not achieve better performance than straight forward indices. It is difficult to justify a 1 to 2% annual fee schedule for yields that are comparable to the wider market. Therefore, it is not surprising to discover that the US trend in financial asset management has been away from the traditional redeemable open ended mutual funds and into various other instruments including the soothingly named Hedge Funds and the novel index tracking Exchange Trade Funds. Upon considering their unpopularity, you might be scratching your heads in wonderment- why do mutual funds perform better with equity in China?

There are two main reasons for choosing any sort of financial vehicle. One is risk management, and the other is performance. In terms of risk, China’s equity exchanges have long been denigrated as corrupt, volatile, and in the worst case scenario, rigged. Stories of government crack down on market manipulation do not reassure an investor as much as it reveals the pervasiveness of corruption. It takes far more experience and expertise to be fully aware of the financial dealings of this market. Because most investors cannot be bothered to develop relations deep into Chinese companies, uncover hidden earnings, and distinguish hearsay and truth, it is advantageous have someone actively managing one’s assets. A good fund manager would have networks (guanxi) into all hidden corners of the Chinese market; therefore, he thrives on volatility, instead of against it.

In terms of performance, Chinese mutual funds have historically outperformed the market composites in the equity portion of their funds, perhaps for the same reason they’re better at volatile risk management. Here is a summary of annual growth rates of the past 5 years I discovered in the book From Wall Street to Great Wall.

Year	Mutual Fund Equity Portion	Shanghai Composite	Shenzhen Composite
2002	-19.47	-17.52	-17.03
2003	31.68	10.27	26.11
2004	-0.63	-15.4	-11.85
2005	-1.28	-8.33	-6.65
2006	102.69	130.43	132.12
Avg	16.01	10.20	14.85

So what does all this mean to the average western investor? Unfortunately for now, unless you could tap into the powers of Mutual Funds simply in terms of Equity, it means fairly little. China’s regulations demand that its mutual funds keep a maximum of 26 percent of its capital in Equity; therefore, their outstanding equity performances are counter-balanced by abysmal performances in Chinese bonds and money market instruments. However, as the Chinese market liberalize and deregulate to allow both investors and managers greater access, there will be plenty of opportunities for the prepared mind.

I will try to give some impressions of the state approved mutual funds sometime later.

-H