Asia is one of the fastest growing and most exciting mutual fund markets. As the region’s economies have remained resilient following the financial crisis, the rising middle class in countries like China, Indonesia and India is getting wealthier and is beginning to dip its toes into the new world of investment funds. Assets under management (AuM) are rising quickly, just as sales slow in Europe.
Regional fund sales were relatively high in 2011, in spite of financial market volatility. Net cash of US$69.4 billion flowed into mutual funds domiciled in Asia and Japan during the year, while Europe’s fund industry actually shrank, according to Strategic Insight. In total, the global fund industry attracted US$200 billion in the year, with Latin America and the US also taking net inflows.
Asia’s fund industry represents a significant growth opportunity for international asset managers, yet distribution in the region is not straightforward. The regional market is geographically fragmented and large consumer banks dominate distribution in some countries. What’s more, fund investors’ preferences vary from one country to another and the local regulatory approach is still evolving. As a result, asset managers distributing in the region need to tailor their approaches to specific markets and remain sensitive to regulatory changes.
Even so, the long-term prospects for Asia’s mutual fund growth look promising. While Asia is home to approximately 60% of the world’s population, Asian investors’ investments only account for 13% of the mutual fund industry’s global AuM, compared to 52% in the Americas and 35% in Europe, according to PwC research. Comparisons of fund AuM to local gross domestic product (GDP) (see table) tell a similar story of low investment. This low penetration means that there is ample opportunity for growth as Asia’s middle classes become wealthier.
UCITS account for most sales
Although asset managers can only sell funds directly to retail investors in established markets such as Singapore, Hong Kong and Taiwan, Europe’s Units in Collective Investments in Transferable Securities (UCITS) funds account for most of the fund sales in these markets. In emerging markets such as Malaysia, Korea and Thailand, offshore funds can only be sold through feeder fund structures or wrapped products. In other markets such as China, India and Indonesia, full distribution of offshore funds is currently not permissible.
The number of UCITS funds registered for sale in Asia is increasing quickly. As at December 2011, 5,614 UCITS’ funds were registered for sale, up from 5,434 in December 2010. Singapore accounted for approximately 2,125 of these funds, and Hong Kong for a further 1,240.
The success of UCITS funds in Asia is a phenomenon of the past ten years. Both the tireless efforts of the European fund industry in promoting the UCITS brand and the signing of memorandums of understanding with the key Asian regulators have opened the doors to cross-border distribution outside of the EU.
Regional UCITS fund registrations
Domestic vs cross-border fund registrations
But Asia’s fragmented geography means that distribution practices vary from one country to another, making distribution across the region expensive. What’s more, large consumer banking platforms dominate distribution in some countries. Sales charges and trailer fees paid to the distributor banks take a hefty chunk out of the fees generated by asset managers, making the cost of distribution higher than that in Europe or the US. This cost is ultimately passed on to the end-investor either as a sales commission, or through higher expense ratios.
Emerging regulatory issues
But challenges to UCITS are emerging, particularly following the launch of greater numbers of funds with embedded derivatives, taking advantage of the UCITS III Directive. Asian regulators are scrutinising these funds before authorising them for sale, especially as investment product mis-selling has created investor suspicion and concern around the safety of such products. While informed investors with a good understanding of the UCITS regulatory framework would not expect funds adopting derivative strategies to be unduly risky, many Asian regulators are not so convinced.
What’s more, the ongoing changes to the UCITS regulatory framework, starting with UCITS II and now moving to UCITS IV and V, are unsettling regulators and leading to delays in fund approvals. For example, the Hong Kong regulator stopped approving synthetic Exchange Traded Funds (ETFs) in July 2010 and only recently approved the first batch of new synthetic ETFs for retail distribution. Beyond the use of derivatives, the ability of fund promoters to change the domicile of management companies, depositories, or fund administrative agents from Luxembourg or Ireland to less established locations is causing regulators to seek greater understanding and clarity about new rules. In particular, they are anxious about the implications for risk management and the equivalence of laws and expectations in new European domiciles with their own in Asia.
Consequently, key players in Europe’s UCITS industry need to communicate with regulators in Asia, so as to build their confidence in the evolution of UCITS funds. Another reason for doing this is the uncertainty caused in Asia by the European debt crisis, which is also undermining confidence in UCITS.
Tomorrow’s Asian fund passport
Looking forward, Asian governments are discussing a local Asian Region Funds Passport. The Asia-Pacific Economic Co-Operation (APEC) organisation is spearheading the initiative, and announced in November 2011 that it supported the establishment of a pilot programme.
While we are still far away from a real pan-Asian cross-border fund recognition framework, the initiative will add fuel to the debate about how Asian countries should protect their domestic fund markets. Many Asian asset managers believe that there is an uneven playing field, not only because Asian funds are not recognised by their neighbouring countries, but also because Asian funds are not recognised for sale in the EU.
Asian governments see a regional funds passport as a way of fostering economic growth in their own economies, with the creation of onshore fund administration, custody and asset management activities. Should this come to pass, it will not diminish the attractions of Asia’s fund market, but will increase the importance of establishing an Asian base for distributing across the region.