Published: May 02, 2012
China has become an attractive investment destination, with both individual investors and companies opening their portfolios to Asia’s largest economy. Companies doing business in China have often faced the challenge of where to put their excess cash, with the best option not necessarily offering a good investment. However, improvements in China’s credit rating and regulatory change have allowed Chinese money markets to develop substantially in recent years. Money market funds (MMFs) and separate accounts have been a product of this development, giving companies in China a broader and better choice of investments for their excess cash.
Companies doing business in China historically had few options to manage their liquidity compared to international markets. Bank deposits have for a long time been the most popular investment choice for excess currency in China. However, as the yields and tenors of bank deposits are regulated by the People’s Bank of China (PBoC), rates are not necessarily aligned to real market yields, and are often lower. The bank deposits also tend to be short-term investments, not suited to companies wanting long cash positions.
Banks in China also offer structured deposits to investors. Some structured deposits are attractive, given their low risk profile, and they generally provide a higher yield than PBoC deposits. However, they are only suitable for short-term investments as they pose liquidity risks as positions can be difficult to unwind before maturity (penalties may apply). Thorough credit analysis is also necessary as the universe is wide, and transparency is usually low.
Another typical investment choice for companies operating in China is direct bond investments – government bonds, financial bonds and corporate bonds. However, gaining access to the market requires proper licences and therefore involves the setup of finance companies onshore or partnerships with brokers. Companies will need to consider whether they have the capabilities to manage such investments, let alone getting access to good pricing.
A key development in recent years has been the introduction of MMFs, providing a real alternative to bank deposits for companies operating in China. Part of this has been due to China becoming a more attractive investment destination, with China’s credit rating rising five notches to AA- in the last ten years. This is an impressively quick increase, and has improved investor confidence in Chinese money markets.
The Chinese money markets also benefit from Asian issuers’ image as an asset sheltered from global volatility, which has been more apparent in recent global volatile markets. Interest rates are also higher in Asian nations, including China, than a lot of developed countries globally, and currencies have been appreciating. A bias is therefore developing towards holding local currencies. In addition, company cash balances are growing faster in Asia than other regions as business expands, and China is helping forefront this trend. With this expansion comes a shift towards maximising returns of the growing pools of excess working capital, equity capital and deal cash.[[[PAGE]]]
Regulation has played a crucial role in the development of China’s money markets. In 2003, the China Securities Regulatory Commission (CSRC) issued guidelines for MMFs. Since then, the MMF offering has grown rapidly; at present, there are 51 MMFs [1], with total assets of RMB 126bn. Most of these funds cater to the retail market and follow the CSRC’s guidelines, which are much broader, in terms of duration and concentration limits, than the international guidelines.
[1] 51 as of Dec 2011. Source: WIND
At J.P. Morgan Asset Management, we launched the CIFM RMB MMF*, the first AAA-rated fund (by Moody’s/CCXI and Fitch) in May 2005. The AAA rating is the highest rating available reflecting the asset quality. Most of the investments are in government issued securities but it still invests in non government securities so it offers a level of diversification and a stable net asset value (NAV). The fund is managed by China International Fund Management Co., Ltd which is a joint venture between Shanghai International Trust Co. Ltd and JPMorgan Asset Management (UK) Ltd.
The CIFM RMB MMF is one of the first institutional/corporate focused liquidity funds in China, and the first real alternative to other cash management tools. The AAA guidelines for the fund were aligned to international MMF standards, more stringent than those of the CSRC, in order to fit easily within most companies’ global investment policies.
The fund provides easy access to the money markets in China, which have historically been difficult for corporates to invest in directly. The fund also provides daily liquidity, with T+1 settlement, and does not charge a penalty fee or a transaction fee for withdrawals.
Since inception, the fund has delivered very competitive returns over short-term PBOC deposits by investing in a broad diversification of high quality securities. According to the 2008 Circular from the Ministry of Finance, returns from mutual fund investments are exempt from Enterprise Income Tax (normal tax bracket at 25%). Therefore, corporate investors will also enjoy this benefit investing in MMFs.
The CIFM RMB MMF has been a good first step outside of other short-term investment options for many companies in China. Given the difference between market yields and regulated deposits, returns in a MMF are often higher, even out to one year, so it is also a possible way to improve returns, while maintaining a level liquidity.
The fund has grown substantially since its launch as demonstrated in Figure 1, as companies operating in China continue to expand their business and use the fund for daily cash management. Growth also reflects the increase in the number of companies and in those companies’ excess cash balances as China’s economy develops and expands.[[[PAGE]]]
Since the regulatory change in 2010, it has been possible to manage separate accounts in China similarly to in other international jurisdictions. Separate accounts in China offer rates that are typically 3-4% higher than in Europe or the US, and boast an attractive credit quality – government securities dominate the underlying market, and, as mentioned previously, their ratings have improved in recent years.
A move towards discretionary portfolios is exciting both for corporates and asset managers. If, as a company, you do not need to hold daily liquidity and you have a reserve cash bucket there are very limited options to take advantage of in China. Discretionary portfolios are an ideal solution as they can exploit the full range of instruments available in the money markets, including inter-bank securities, and fully customise these to each client.
In addition, investing in a discretionary portfolio can provide instant scalability of cash. Clients with large balances often maintain a concentration cap as to how much they can invest in an individual fund. However, with a discretionary portfolio, even as cash balances grow, the same amount of diversification can be achieved in the single investment vehicle.
China has become a more attractive investment destination and, as a result of rapid growth, company cash balances have expanded. With the advent of regulatory change, the money markets have also been allowed to grow. The proliferation of MMFs and, more recently, discretionary portfolios has given companies more options for investing excess cash, and means they no longer need to rely on bank deposits.
Through MMFs and discretionary portfolios companies can now optimise their cash investments in China. What is more, China’s growth is likely to continue, and along with that, the need for investment solutions for the increasing amounts of excess cash on company balance sheets. To accommodate this, at J.P. Morgan Asset Management we have expanded our credit analyst team into Asia over the past 12 months to ensure we can cover more issuers. We are also planning to expand our platform in Asia this year, and develop more products in key strategic markets like China.
(click above image to enlarge)
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