China Allows Retail Investment in US Equities

♠ Posted by Emmanuel in at 4/08/2008 12:27:00 AM
This bit of news is significant not so much for its immediate effects--I hardly think Chinese domestic investors will begin piling into American stocks rights now--but for what it may mean in the future. Will more significant Chinese investment in the US eventually result in additional protectionist rhetoric if and when American stock markets recover? We'll see. Before reaching the US, China's Qualified Domestic Institutional Investor (QDII) scheme allowed relatively well-heeled and adventurous Chinese investors to place their funds in Singapore, Hong Kong, Japan, and the UK. What remains to be seen is whether investing in the States will become an attractive option for the Chinese as the subprime debacle works its way out. Here is the story from MarketWatch, although there's more that I have to add after this:

China banking and securities regulators signed an agreement with their U.S. counterparts Monday that will help to lay the groundwork to enable Chinese investors to buy and sell U.S. stocks and mutual funds.

The agreement signed between the Securities and Exchange Commission and the China Banking Regulatory Commission marks a further expansion of QDII -- the qualified domestic institutional investor program -- and brings the U.S. in line with similar agreements signed between Beijing and regulators in Singapore, Hong Kong, Japan and the U.K.

China banking and securities regulators signed an agreement with their U.S. counterparts Monday that will help to lay the groundwork to enable Chinese investors to buy and sell U.S. stocks and mutual funds. According to data from the U.S. Treasury Department from last June, China held $922 billion in U.S. securities -- but only $29 billion of that in U.S. stocks. Most of the rest is held in U.S. government bonds.

"What we've seen over the last six to 12 months, China has a lot of capital and is looking for ways to make that capital work harder and more efficiently," said Charlie Awdry, a fund manager for Gartmore's China Opportunities Fund. "This is illustrative of the broader engagement between China and the rest of the world."

Analysts said Chinese banks may not be in much of a rush to invest in the U.S., however. "It's significant in the sense that, in the long run, Chinese money will invest in the U.S., but this is just part of the ongoing process," said Lan Xue, Citigroup's head of China research in Hong Kong. "The actual implementation will be long and slow," said Gartmore's Awdry.

Glenn Maguire, head of Asian economic research for Societe Generale in Hong Kong, pointed out that investors bid up Hong Kong-listed stocks on a similar announcement, but the money from the mainland largely didn't materialize. "Any type of change to capital outflows is evolutionary rather than revolutionary," he said. Because of the appreciation in the yuan, stress in the U.S. financial sector and the upcoming U.S. presidential election, Chinese banks might not exhibit such a great appetite for U.S. equities, he said.

So far, China's institutions and sovereign wealth funds have suffered from investing in financial-services stocks like Blackstone Group, Merrill Lynch & Co. and the U.K.'s Barclays. Still, Shanghai-listed stocks have done ever worse than their U.S. counterparts this year. The Shanghai Composite is down over 30%, compared to the 6.7% fall for the S&P 500.

The natural thing you will want to ask is how well the QDII has done before entering this extended pact with the SEC to allow Chinese retail investors in American markets. Our favourite official publication, the China Daily, says not well at all since virtually all the existing QDII funds had negative returns (dontcha just love that oxymoron) in 2007. Worse, one of the QDII schemes went kaput. Interestingly, though, the article suggests there is no shortage of FIs wanting to set up their own QDII schemes in the meantime:

China's four stock-oriented qualified domestic institutional investor (QDII) funds have all reported big losses last year, and fund management companies blamed the failing performance on the US subprime crisis that caused volatility in the world market, Monday's China Securities Journal reported.

Net value of the four QDII products - JP Morgan Fund QDII, Harvest Overseas Fund, Huaxia Global Selected Stock Fund and Southern Global Enhanced Balanced Fund - shrank by 6.3 percent to 12.1 percent of its initial value by the end of last year, according to their 2007 annual reports.

Southern Global made the smallest loss in net value while Harvest Overseas suffered most. Reports in December said Southern Global suffered slightest slump in net value as it positioned more in funds than in stocks.

In the meantime, the four products also posted negative growth over the earlier-fixed benchmark growth rate, which serves as a major reference for investors to judge the performance of a fund, the biggest negative growth rate, at 10.91 percent, was Harvest Overseas Fund.

By March 22, all four stock-oriented QDII funds saw their net value fall below one yuan (14.3 US cents), the value set for fund subscriptions, with Southern Global at 0.765 yuan, Huaxia Global at 0.713 yuan, Harvest Overseas at 0.613 yuan and JP Morgan at 0.632 yuan.

The US subprime crisis should be blamed, the four fund management companies said in their annual reports. Huaxia Global said the world stock market, emerging markets segment in particular, was badly hit by a slowdown in the US economy as well as the world economy after the subprime crises surfaced in the second half of last year in the United States. Southern Global said the negative earnings were due to the adjustment of the world market under the influence of the subprime risks. However, Harvest Overseas cited as well the appreciation of the Chinese currency against the dollar during the period for its huge losses.

These four QDII funds, Southern Global being the first approved in September last year to invest 100 percent of its assets in global stock markets instead of low-risk, low-return bond and currency markets only, currently invested heavily in the Hong Kong market, which was vulnerable to difficult conditions of the US market.

However, the pace of growth of QDII funds in China was not hampered. Apart from the fifth QDII fund already launched in January, namely ICBC Credit Suisse China Chance Global Allocation Fund, several other fund management companies have recently gained QDII status and are preparing to launch their QDII products.

They include Huabao Industrial Fund Management Ltd, Fortis Haitong Investment Management Co Ltd, China Universal Asset Management Co Ltd and E-fund Management Co Ltd…

Many of China's QDII funds and products, including bank-backed funds, were pushed into a loss as the US credit crisis began to unfold and spread. China Minsheng Banking Corp said on March 19 that it would liquidate a QDII fund and repay investors, as required if the fund's assets fell below 50 percent of their initial value. This had raised concern about a wider failure of QDII products. China's banking supervisor on Friday had asked banks to fully evaluate investors' risk tolerance shortly after the liquidation announcement from Minsheng.