Chinese Mutual Funds Need Regulatory Reform

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China is one of the fastest growing economies over the last two decades, and the mutual funds industry hardly lagged. China, the most populous country in the world, could take over America as the world’s largest economy. However, according to Robert Pozen, Author of The Fund Industry, mutual funds are facing tough times due to weak regulations, which need reform.

One of the major predicaments facing China’s fund business is the attitude of retailers. Pozen notes that, most Chinese retailers are deluded to making quick money, and hence their investment goals are unfounded. They focus on the short term gains; something that has led to massive exists within a short period. The in and out factor is destabilizing the market and hence stringent measures need to be taken to increase investor confidence.

  • Pozen says, “this flood of new funds is partly caused by large up-front commissions on fund sales paid to distributors, who also receive smaller fees on an annual basis. To collect these up-front commissions, distributors hype the new funds and investors rush to buy. Unfortunately,  these investors hold for a relatively short time – until the next wave of new funds.”

Additionally, Pozen notes that one of the reasons investors are focusing on myopic investments, is the frequency and number of funds that are introduced in the market. New funds are promoted far more than existing funds. Even-though the Chinese fund business has less than 1000 mutual funds, the frequency and the number in which they are being introduced is alarming. In 2010 alone, 136 mutual funds were created.

Mutual funds provide better returns when an investor takes a long-term view, of between 3 to 5 years. However, abrupt in and outs can only lead to massive under-performance, which could prove detrimental to the funds’ business altogether.

Mulling over Solutions

There  are a couple of solutions for Chinese regulators. Firstly, it would be important to revise the up-front commissions to a lower rate that will dissuade the retailers from engaging in greedy, dishonest business.  This is likely to control the number of new funds introduced in the market. The ripple effect of this, could result in investors establishing long-term goals for their portfolios. This would result in higher returns and consequently boost investor confidence.

Another solution would be to expand the industry platform, to include mutual fund management firms, other than cocooning the funds business within the largest banks in china.

Sources familiar with the matter have told us that most investment firms in China are large in terms of assets. It is far different from America, where hedge funds are formed sometimes with less than $1 million under management. In China to get a license to open an asset management firm, bribes of local officials is a requirement. Therefore, usually only large institutions exit (and can expand).

Pozen says that banks treat  mutual funds like any other financial instrument within their product line. Optimistically, the fund management firm will be able to restore investor confidence by offering advisory services on a personal basis to the investors. On a positive note, the Chinese government has already allowed four mutual fund management firms to engage in the funds business as of 2012.

The third solution focuses on the policy makers, as they could play their part by promoting retirement savings schemes, either by offering subsidies or tax advantages. This would prolong the investment horizons, as investors will seek to benefit in terms of capital/interest gains and tax advantages.

Nonetheless, the biggest challenge is changing the mind-set of the Chinese people who have completely lost trust in the country’s financial markets, continuously linked with scandals. They all seem to have short-term goals, and it will require all sections of the financial system to play their part to finally, restore financial order.


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