Huge growth in China’s money funds poses risk
Bullish: Chinese money funds look likely to retain strong retail investor interest
China’s asset management industry has had explosive growth in the last two years following the arrival of online money market funds, which have transformed the way millions of Chinese invest their savings.
The booming popularity of money funds, however, has led several investment experts to raise serious concerns about risks developing in the industry as a result.
The funds’ appeal is strong given that most of them offer annual returns of 4-6 per cent, compared with the 3 per cent Chinese individuals receive on their bank deposits. The returns have helped money market funds’ assets under management grow nearly 15-fold in the past four years to Rmb1.9tn ($306bn) at the end of 2014, according to Goldman Sachs Asset Management.
Robert Pozen, senior lecturer at Harvard Business School and former chairman of MFS Investment Management, the oldest US mutual fund company, fears investors are being drawn to the high interest rates without any understanding of the risks.
The funds offer high interest rates, he says, but “they are not explaining that in many cases this type of paper is not top quality. This is essentially what we would call primary junk funds in the US — paper that’s usually below investment grade, fluctuates daily in terms of interest rates and from time to time defaults.
“The big risk is selling to relatively unsophisticated investors over the internet who probably do not know what they are getting into. There is a real possibility of loss here.”
The biggest winners from the influx of cash into online money funds have been large Chinese internet companies like Alibaba, Tencent and Baidu. They were quick to recognise that selling money funds over the internet to consumers who were comfortable with online transactions could translate into big business.
Alibaba’s money fund Yu’E Bao (Leftover Treasure), which is marketed to users of the group’s online payment platform Alipay, has been particularly successful. Cash transfers from bank accounts to Yu’E Bao take just one click. Its assets have risen from zero to Rmb578bn in less than two years.
Rating agency Fitch has highlighted the level of retail investor cash flowing into the funds as a cause for concern. It noted in a report written last month that yield-hungry retail investors are prone to herding patterns of behaviour when markets become stressed, which could lead to “periods of mass fund exodus”.
This is particularly worrying because Chinese retail money funds invest heavily in deposits and bonds with long maturity dates in order to keep yields competitive, say Fitch analysts Alastair Sewell and Li Huang. The money funds have a minimum investment threshold of just Rmb1 and investors can redeem their holdings at any time, potentially creating a large liquidity mismatch.
“Since e-commerce money market funds are retail-focused, they tend to have a less stable investor base,” say the Fitch analysts. Meeting redemptions in a stressed market “may challenge those funds with higher exposures to less liquid securities, larger funds and those with more concentrated investor bases”. Meeting large outflows “could be problematic”.
Flows to online money market funds have slowed in 2015 but most commentators agree that they will continue to attract large numbers of retail investors in the next two years. Stephen Tu, vice-president at rating agency Moody’s, says Chinese money funds have “only captured a relatively small percentage of the total savings and liquidity in China”. The pool of investors drawn to such products is likely to expand given new technology companies with big customer networks continue to enter the money fund industry.
Xiaomi, the world’s third-largest smartphone maker, is the latest. It said last month it would team up with asset manager E Fund Management to sell a money-market fund through a finance app bundled on the technology company’s operating system.
“It’s a nascent environment now and there are likely to be more entrants,” says Mr Tu. “In the long run, we could see a handful of key players providing these services.” Online money market funds are more convenient than traditional bank accounts, he adds.
Mr Tu agrees that the rapid growth of the industry is a potential concern but believes other areas of China’s financial services industry — notably shadow banking and private lending — require more immediate attention.
Chris Powers, analyst at Z-Ben Advisors, the Shanghai-based asset management consultancy, adds that the focus by some on money funds is perhaps misplaced. “It’s difficult in China to really isolate money market funds,” he says. “There is concern about all financial products in China and money market funds would probably be considered the most secure. I don’t think there is any concern [among] investors here about the risks.”
The Chinese government may be stalling on applying more rigorous oversight to money funds partly because the industry’s growth is considered a success for China’s market liberalisation. “I think the authorities are hesitant to [increase] regulation of the funds as it is one of the most exciting areas of Chinese finance,” says Mr Powers. “They are accomplishing a lot of their goals here.”
But the People’s Bank of China has expressed concern about how some money funds are being marketed, notes Mr Powers. “You do see aggressive 8 or 9 per cent guarantees.”
The Chinese authorities should be more proactive, according to Mr Pozen. “Do investors in China know what kind of fund they are getting into?” he asks. “Do they realise it is a fluctuating junk bond fund and not a safe money market fund? “I bet a lot of people do not understand those risks.” These funds need to be labelled properly, he adds, and the value of their underlying holdings needs to be “disclosed properly”.