My Blog

January 19, 2008

My previous (January 16) posting on QDIIs elicited a lot of comment and disagreement, so I thought I would return to the subject with some additional information on why I think that earlier enthusiasm for QDIIs is likely to be short-lived.

The ICBC/Credit Suisse joint venture recently launched its own newly-created QDII.  The fund had planned to raise RMB 22 billion ($3 billion) during a January 3 to February 1 subscription period for the fund.  The previous four QDIIs launched in September, October and November of 2007 (JP Morgan Fund QDII, Harvest Overseas Fund, Huaxia Global Selected Stock Fund, and Southern Global Enhanced Balanced Fund) all saw their larger quotas oversubscribed on the first day of subscription.   China Southern, the first mutual fund QDII, closed its 14-day subscription period on September 12, the first day of launch, when its $2 billion fund (subsequently increased to $4 billion) received nearly $7 billion in demand.  The October 9 launch of the $4 billion Harvest fund, the second mutual fund QDII, received nearly $10 billion on the first day of subscription.

It was this enthusiastic oversubscription that elicited hope that QDIIs might actually become a significant form of outward portfolio investment and so help ease pressures on the PBoC, whose most daunting challenge is to regain control of domestic monetary policy as it is forced to monetize the huge build up in China’s foreign currency reserves.  Given rising RMB expectations I was, and continue to be, very doubtful that this big outflow would materialize.  I expected that losses by the established QDIIs would turn Chinese investors away from further investing, and when Credit Suisse reported that to date QDIIs have run large losses, I figured that QDII enthusiasm would quickly dry up.

The experience of the current ICBC/Credit Suisse QDII launch gives us some (but of course not conclusive) evidence that this may be the case.  According to today’s China Daily, subscriptions for ICBC/Credit Suisse have been so weak two weeks into the one-month subscription period that “insiders said they were worried the fund cannot reach the planned scale before the subscription period ends.”  Part of the reason for the very poor showing, compared to the enthusiasm of just two and three months ago, may have to do with the fact that we are in the pre-holiday period and that global and local markets have recently been sluggish to awful, but I continue to believe that this lack of enthusiasm was more or less inevitable.

The combination of poor international markets and a rising RMB have slammed the performance of the previous four QDIIs – losses in the two to four months they have been in operation averaged 12% – and I am pretty sure that expected RMB appreciation of 7-9% this year will either lead to more weak performances or else force QDIIs to respond by taking on unhealthy risks.  Even if some funds do take on these risks and get lucky and do well, others will do much worse, and so the net impact will be to keep enthusiasm for QDIIs low.  This expected bad performance might not happen, of course, if global risk appetite suddenly turns around and global markets surge by well over the expected RMB appreciation, although in that case I suspect local markets will anyway outperform.   

This new fund is not the end of the story of course.  There are several more QDIIs slated to come out. China Daily goes on to say “Despite the dwindling attraction of QDII products, seven domestic securities firms have recently acquired QDII status and are making preparations for new products.”  They quote a research analyst who expects that QDII funds may do better in the future by focusing on new emerging capital markets in countries such as Brazil, Russia and India. 

Why does that not make me feel better?

On a not completely unrelated topic, the China Daily today also reports that Chinese employers have the dual problem of having to deal with both the biggest salary increases in Asia and the highest turnover in Asia.  A survey by a human resources company claims that nearly all the China-based companies they surveyed across a wide range of industries are raising salaries and bonuses substantially, and nearly one-third (32%) of those they surveyed planned to raise salaries by at least 20%.  Nonetheless in spite of surging compensation nearly half the companies across all industries had turnover of 10% or more in 2007 and more than one-eights had turnover that exceeded 20%.  Staff turnover in China was more than double that of Japan.

This isn’t a surprise to me.  I am sure all of us working in China have heard horror stories ad nauseum about the problems of high turnover, and nowhere is this more evident than in the field of finance.  As a former banker/trader now teaching finance, one of my extracurricular activities at Peking University is to help my current and former students get good jobs in the banking and finance industries, and so I spend a lot of time working with senior investment bankers on recruiting.  In the six years I have been here, salaries for junior bankers have risen sharply and nearly everyone in the industry with whom I speak complains of turnover as being one of the biggest headaches faced by the banks.  I am also on the board of directors of a recently-established fund management company, created as a joint venture between a European and a Chinese bank, and I am very aware of the difficulties we have had in getting senior staffing. 

None of this gives me great confidence about how all these new QDIIs are expected to manage riskier portfolios.  Still, since I am considering returning to the market when opportunities open up in Beijing, this report of higher salaries and high staff turnover isn’t all bad news, I guess.

Comments (3) for "More on QDIIs (and Chinese s...

I'm in the "glass half open" mode. The fact that people realize that they can lose money in the stock market and aren't investing for the next quarter is by and large a very good thing. Having people investing for the long haul is precisely what China needs, and having an investor base that doesn't care what the fund does in the next quarter reduces the pressure for fund managers to take extreme risks. The question is the total amount of QDII that is going to be subscribed, and I suspect that close to the $90 billion is going to be subscribed to in the end. The main reason for this is that a pretty large fraction of the QDII quota is going to subscribed to by insurance companies and pension funds, and they aren't (or at least shouldn't be) hugely influenced by a drop in the market. (And a 10% drop in one quarter is something that just happens from time to time.) The QDII subscription isn't going to resolve the underlying issue of reserve growth, but it is going to counteract the effects of hot money inflow in response to appreciation. The other thing is that QDII creates something of an investor culture and the amount of technical and IT experience that Chinese finance companies need to manage QDII is non-trivial, and that will be useful in the middle and long term. By Twofish - 1/20/2008 2:06 AM

I don't disagree at all, Twofish. I support the establishment of QDIIs and anything else that increases the sophistication and development of Chinese financial markets. I just don't think they are going to have nearly the effect that many others think on short-term capital flows, and China's monetary problem must be resolved in the short term. By Michael Pettis - 1/20/2008 7:13 PM

the argument is now kind of moot> both A and HK market collapsed before investor eyes. 5 Y bull market is coming to end and THIS IS BEAR market. I am very sorry for the QDII investor and Chinese Public funds -CIC,SAFE and Public banks, cumulative total loss now closing US$10b since August. By isaac - 1/21/2008 5:33 PM