Global Hedge Funds Struggle Even in a More Open China Market

(Bloomberg) -- Global asset managers are struggling to find a foothold in China’s 3.74 trillion yuan ($578 billion) hedge fund industry, despite long-awaited policy changes designed to give foreigners more paths to invest.

In November, China expanded access for more than 400 foreign institutions like UBS Group AG and Citigroup Inc., allowing them to invest through private securities funds, the local version of hedge funds. Global players hoped a new fundraising channel would give their struggling local businesses a quick boost, and many began adding headcount soon after regulators signaled the easing in 2019, said Eric Zhu, head of financial services at recruiter Morgan McKinley.

But reality has not lived up to expectations, and local players continue to dominate. Despite the policy easing, most existing hedge fund products remain off limits for qualified foreign institutional investors and RQFIIs, their local currency-based equivalent.

Global firms had already won permission to pump $227 billion into the mainland market before quotas were scrapped to encourage more inflows, but much of that capacity remains untapped by the local units of giants like Bridgewater Associates. In addition, Chinese investors are more familiar with the brand names and track records of local firms such as Shanghai Greenwoods Asset Management and Perseverance Asset Management.

At a recent meeting with regulators, global managers expressed frustration at the limitations they face, as well as the lack of tax incentives, according to people with knowledge of the matter, who asked not to be named as the discussions were private. However they got few assurances of further easing ahead.

Overall asset growth at global players’ onshore units will “likely remain slow in the coming few years, even if there could be exceptions,” said Yin Tianyuan, head of research at Shanghai Suntime Information Technology Co.

While more than 30 foreign managers have set up shop, they are competing with nearly 9,000 local rivals. Chinese hedge funds face frustrations too, though. Those hoping for more business from international players have also been disappointed after the policy relaxations left most hedge fund products out of reach.

Foreign firms should focus more on research, developing differentiated products and delivering appealing returns, said Yin. “In asset management, performance is the only shortcut.”

China’s policymakers need to balance growth with limiting risk, said Fuxin Wang, an analyst tracking hedge funds at Shanghai Securities Co. “That leads to the step-by-step approach, which would unavoidably straitjacket what they can do from time to time.”

While QFIIs will be able to trade commodity futures and options as soon as regulators hammer out details, there has been no sign that derivatives like cross-border return swaps, which local hedge funds use widely, would be allowed.

Policy restrictions hamper global managers’ local hedge fund units much less than their lack of distribution channels, brand recognition and star managers, said Allen Wang, a senior lawyer at Fangda Partners who previously spent 13 years working for global firms in China. Having limited assets under management curbs trading capacity even in permitted instruments, he added.

“The QFII rules are not tailored” for hedge funds, Wang said. “Allowing a feeder money channel is already a big favor.”

Barings LLC on Dec. 15 became the first global investor to tap the new channel, using its own money to subscribe to a bond product launched by its Shanghai-based hedge fund unit to support its growth, according to its WeChat announcement. The city’s financial bureau said it helped by addressing the “barriers and bottlenecks,” without elaborating.

The QFII policy “will help even if it’s ‘house’ money,” said Peter Alexander, managing director of Shanghai-based Z-Ben Advisors Ltd. “Third-party funds will be very competitive,” he said, although domestic money, rather than QFII mandates, should be the main target for setting up a local hedge fund business.

Despite the remaining obstacles, global firms remain keen for local clients’ business, particularly institutional money like pension funds, Morgan McKinley’s Zhu said. Some firms still plan a headcount increase of at least 20% for their local asset management units, he said, declining to name specific clients.

“Many of them are moving full speed ahead,” Zhu said. “When everything is in place, where can you still make money?”