Vanguard's China fund market strategy under a cloud after Asia setbacks

© Reuters.

By Samuel Shen and Alun John

SHANGHAI/HONG KONG (Reuters) - As Vanguard Group doubles down on mainland China's $2.6 trillion mutual funds market, the U.S. asset manager faces challenges similar to those that forced it to abandon Hong Kong, Japan and Singapore.

The world's biggest mutual fund company announced last week it is closing its Hong Kong and Japan operations and shifting its Asian headquarters to Shanghai, where it is expected to establish a mutual fund unit. The Pennsylvania-based money manager exited Singapore two years ago.

"Vanguard failed in Singapore. It just failed in Hong Kong. Why do you think coming to the mainland is going to work?" said Peter Alexander, founder of Z-Ben Advisors, who has worked in China's mutual fund industry since its inception in 1997.

Alexander and some other industry veterans argue Vanguard's direct-to-client, low-fee sales model, which proved so successful in North America, did not work in Hong Kong because it was poorly suited to most Asian markets where investment products are typically sold by agents who live on commission. That is incompatible with Vanguard's core tenet of never paying for distribution. China's 1.4 billion population appears enticing for Vanguard, especially the exchange-traded funds (ETFs) segment. The mainland's overall mutual funds market is forecast to more than triple to 60 trillion yuan ($8.75 trillion) in a decade, according to Z-Ben.

Several other international players including BlackRock (N:BLK), Fidelity and Neuberger Berman are also preparing to establish wholly owned retail fund businesses in China after foreign ownership restrictions were scrapped earlier this year.

But, like Hong Kong, China is a pay-to-access fund market where actively-managed products are more popular. And commission-based sales agents have little incentive to sell low-fee ETFs.

China's biggest ETF manager China Asset Management Co said ETFs were popular in the United States because beating benchmarks consistently was difficult there, and investment advisers often recommend low-cost products. However, in China investors regularly aspire to beat the market.

"Many global players know China is very important, but once the real fights begin they often find themselves unaccustomed to the local battle ground," said Jasper Yip, Hong Kong-based principal at management consultancy Oliver Wyman.

In a statement about its Asia strategy, Vanguard drew a parallel with widespread doubts about its pioneering - and ultimately hugely successful - index mutual funds when founder John Bogle launched them in the 70s.

"Just as we advise our clients to invest for the long term, as a firm, we also are patient and take the long view on our business strategies," the world's second-biggest ETF manager said.

To tap a growing online investment community, Vanguard has formed a minority-owned China investment advisory joint venture with the country's leading fintech company Ant Group.

Alexander of Z-Ben and other industry executives say Vanguard risks the same problems many other Sino-foreign ventures experienced: cultural clashes, and being sidelined. This is heightened because Ant controls the fund advisory business and has a majority stake in another Chinese mutual house which sells ETFs.

"There's no doubt that there will be power struggles in a JV," said a senior executive of a Chinese mutual fund house on condition of anonymity. "I met some U.S. fund executives who are idealistic and want to replicate their U.S. practice in China. In reality, it doesn't work."