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Vanguard exit from China state fund mandates prompts speculation

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Vanguard’s decision to abandon millions of dollars in fees from China’s most influential state-backed asset owners at the same time as announcing plans to move its regional headquarters to Shanghai has shocked many industry observers.

The US asset manager was charging about 1.5 basis points for running a $10bn portfolio for the State Administration of Foreign Exchange, about 2 bps for a $10bn mandate from China Investment Corporation and 3.5 bps for $1.6bn outsourced from the National Social Security Fund, sources have confirmed.

Exclusive data from informed parties suggest that Vanguard may have been earning about $4m per year in management fees from the three passively managed mandates in China. Ignites Asia reported Vanguard was pulling out of high-profile discretionary mandates last week.

The fees Vanguard has been charging China’s largest asset owners are not far off from the industry norm, experts said.

“I’d be surprised if the decision were purely linked to the existing fee levels,” said Nigel Birch, London-based senior director at Broadridge. 

This article was previously published by Ignites Asia, a title owned by the FT Group.

The mandates Vanguard ran for CIC did not take a lot of management personnel to maintain and it is possible that Vanguard received regulatory or even political pressure to force it out of the business, according to one source close to the matter.

Vanguard won the passive mandate from state-funded pension the NSSF only five years ago in December 2015.

Whatever the reasons for Vanguard cutting ties with the trio of big Chinese institutions, the implications of the decision could go beyond simple monetary metrics.

The state funds are “surprised” by the sudden request as it is the first external manager to have withdrawn from running portfolios for them, according to one person familiar with the matter.

“The first reaction from people within and outside of CIC is that the decision is beyond comprehension,” another person familiar with the matter said.

Some said the move could risk jeopardising Vanguard’s ambitions for expansion in China’s retail market.

If Chinese authorities view Vanguard’s decision negatively, the move could “backfire” on the firm’s expansion plans when it comes to securing a licence or obtaining outbound investment quotas in the future, one of the people familiar with the matter said.

Having shuttered its Hong Kong and Japan offices, Vanguard is moving its regional headquarters to Shanghai, Ignites Asia reported in August. The move means the US company is betting big on building a strong, profitable business in China’s retail funds market.

The company is in the process of preparing to apply for a public fund management licence that will allow it to manufacture and distribute funds to retail investors in the market.

This is in addition to the fund advisory joint-venture partnership Vanguard is already running with China’s tech giant Ant Group, which now serves about 370,000 individual investors in the market.

Given that these are the most influential institutional clients and regulators, there was a feeling in the domestic investment community that Vanguard was not making a “sensible decision” in shutting down the big accounts, a chief investment officer at a large domestic Chinese asset manager said.

“How could it on one hand expand aggressively in China then pull out from big clients like China’s state-affiliated asset owners?” another person familiar with the matter said, adding, however, that there was no clear conflict between the existing institutional business line and the new opportunity in the retail space.

Peter Alexander, managing director at Shanghai consultancy Z-Ben, said it was “highly unlikely” that the move by Vanguard would impair other plans including its retail fund management application.

“If I do A, will that negatively impact B?” is very dated thinking, he added, “It’s 2020 and Chinese decision making has evolved greatly”.

Also, with sophisticated large asset owners in China increasingly cutting outsourced portions, dropping them could be a “smart move”, he said.

“We’ve known for a rather long time that CIC and SAFE were moving to in-house an increasingly level of investments with the NSSF still more willing to farm out work although mostly in the [alternatives] space,” Mr Alexander added.

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For instance, CIC’s externally managed assets peaked in 2014 at 68 per cent of its total assets under management but has been declining ever since and is now 52 per cent, according to data compiled by Z-Ben.

Mr Alexander speculated that the three institutions could have been pushing for zero fees, adding that he had observed intense competition and fee suppression across all asset classes with the exception of niche investment strategies, which are mostly in the alternatives space.

However, the bold move to abandon the mandates could be part of a wider regional shift across the Asia-Pacific region for Vanguard to turn away opportunities for relatively low-fee passive institutional mandate business and seek more profitable business opportunities.

Earlier this month, Vanguard confirmed that it would be terminating mandates with 12 institutional investors in Australia after also deciding to pivot away from lower-fee institutional business in both Australia and New Zealand to focus on higher-margin services for retail investors in the two countries.

Vanguard declined to comment for this article when contacted by Ignites Asia.

*Ignites Asia is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignitesasia.com.



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Financial bubbles also lead to golden ages of productive growth

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Sir Alastair Morton had a volcanic temper. I know this because a story I wrote in the early 1990s questioning whether Eurotunnel’s shares were worth anything triggered an eruption from the company’s then boss. Calls were made, voices raised, resignations demanded. 

Thankfully, I kept my job. Eurotunnel’s equity was also soon crushed under a mountain of debt. Nevertheless, the company was refinanced and the project completed. I raised a glass to Morton’s ferocious determination on a Eurostar train to Paris a decade later.

With hindsight, Eurotunnel was a classic example of a productive bubble in miniature. Amid great euphoria about the wonders of sub-Channel travel, capital was sucked into financing a great enterprise of unknown worth.

Sadly, Eurotunnel’s earliest backers were not among its financial beneficiaries. But the infrastructure was built and, pandemics aside, it provides a wonderful service and makes a return. It was a lesson on how markets habitually guess the right direction of travel, even if they misjudge the speed and scale of value creation.

That is worth thinking about as we worry whether our overinflated markets are about to burst. Will something productive emerge from this bubble? Or will it just be a question of apportioning losses? “All productive bubbles generate a lot of waste. The question is what they leave behind,” says Bill Janeway, the veteran investor.

Fuelled by cheap money and fevered imaginations, funds have been pouring into exotic investments typical of a late-stage bull market. Many commentators have drawn comparisons between the tech bubble of 2000 and the environmental, social and governance frenzy of today. Some $347bn flowed into ESG investment funds last year and a record $490bn of ESG bonds were issued. 

Last month, Nicolai Tangen, the head of Norway’s $1.3tn sovereign wealth fund, said that investors had been right to back tech companies in the late 1990s — even if valuations went too high — just as they were right to back ESG stocks today. “What is happening in the green shift is extremely important and real,” Tangen said. “But to what extent stock prices reflect it correctly is another question.”

If the past is any guide to the future, we can hope that this proves to be a productive bubble, whatever short-term financial carnage may ensue.

In her book Technological Revolutions and Financial Capital, the economist Carlota Perez argues that financial excesses and productivity explosions are “interrelated and interdependent”. In fact, past market bubbles were often the mechanisms by which unproven technologies were funded and diffused — even if “brilliant successes and innovations” shared the stage with “great manias and outrageous swindles”.

In Perez’s reckoning, this cycle has occurred five times in the past 250 years: during the Industrial Revolution beginning in the 1770s, the steam and railway revolution in the 1820s, the electricity revolution in the 1870s, the oil, car and mass production revolution in the 1900s and the information technology revolution in the 1970s. 

Each of these revolutions was accompanied by bursts of wild financial speculation and followed by a golden age of productivity increases: the Victorian boom in Britain, the Roaring Twenties in the US, les trente glorieuses in postwar France, for example.

When I spoke with Perez, she guessed we were about halfway through our latest technological revolution, moving from a phase of narrow installation of new technologies such as artificial intelligence, electric vehicles, 3D printing and vertical farms to one of mass deployment.

Whether we will subsequently enter a golden age of productivity, however, will depend on creating new institutions to manage this technological transformation and green transition, and pursuing the right economic policies.

To achieve “smart, green, fair and global” economic growth, Perez argues the top priority should be to transform our taxation system, cutting the burden on labour and long-term investment returns, and further shifting it on to materials, transport and dirty energy.

“We need economic growth but we need to change the nature of economic growth,” she says. “We have to radically change relative cost structures to make it more expensive to do the wrong thing and cheaper to do the right thing.”

Albeit with excessive enthusiasm, financial markets have bet on a greener future and begun funding the technologies needed to bring it to life. But, just as in previous technological revolutions, politicians must now play their part in shaping a productive result.

john.thornhill@ft.com



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US tech stocks fall as government bond sell-off resumes

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A sell-off in US government bonds intensified on Wednesday, sending technology stocks sharply lower for a second straight day.

The yield on the 10-year US Treasury bond, which acts as a benchmark for global borrowing costs, climbed to nearly 1.5 per cent at one point. It later settled around 1.47 per cent, up nearly 0.08 percentage points on the day.

Treasury trading has been particularly volatile for a week now — 10-year yields briefly eclipsed 1.6 per cent last Thursday — but the rise in yields has been picking up pace since the start of the year and the moves have begun weighing heavily on US stocks.

This has been especially true for high-growth technology companies whose valuations have been underpinned by low rates. The tech-focused Nasdaq Composite index was down 2.7 per cent on Wednesday, on top of a 1.7 per cent drop the day before.

The broader S&P 500 fell by 1.3 per cent.

The US Senate has begun considering President Joe Biden’s $1.9tn stimulus package, with analysts predicting that the enormous amount of fiscal spending will boost not only economic growth but also consumer prices. The five-year break-even rate — a measure of investors’ medium-term inflation expectations — hit 2.5 per cent on Wednesday for the first time since 2008.

Inflation makes bonds less attractive by eroding the value of their income payments.

“I would expect US Treasuries to continue selling off,” said Didier Borowski, head of global views at fund manager Amundi. “There is clearly a big stimulus package coming and I expect a further US infrastructure plan to pass Congress by the end of the year.”

Mark Holman, chief executive of TwentyFour Asset Management, said he could see 10-year yields eventually trading around 1.75 per cent as the economic recovery gains traction later this year.

“It will be a very strong second half,” he said.

Line chart of Five-year break-even rate (%) showing US medium-term inflation expectations hit 13-year high

Elsewhere, the yield on 10-year UK gilts rose more than 0.09 percentage points to 0.78 per cent, propelled by expectations of a rise in government borrowing and spending following the UK Budget.

Sovereign bonds also sold off across the eurozone, with the yield on Germany’s equivalent benchmark note rising more than 0.06 percentage points to minus 0.29 per cent. This was an example of “contagion” that was not justified “by the economic fundamentals of the eurozone”, Borowski said, where the rollout of coronavirus vaccines in the eurozone has been slower than in the US and UK.

The tumult in global government bond markets partly reflects bets by some traders that the US Federal Reserve will be pushed into tightening monetary policy sooner than expected, influencing the costs of doing business for companies worldwide, although the world’s most powerful central bank has been vocal that it has no immediate plans to do so.

Lael Brainard, a Fed governor, said on Tuesday evening that the ructions in US government bond markets had “caught my eye”. In comments reported by Bloomberg she said it would take “some time” for the central bank to wind down the $120bn-plus of monthly asset purchases it has carried out since last March.

After a series of record highs for global equities as recently as last month, stocks were “priced for perfection” and “very sensitive” to interest rate expectations that determine how investors value companies’ future cash flows, said Tancredi Cordero, chief executive of investment strategy boutique Kuros Associates.

Europe’s Stoxx 600 equity index closed down 0.1 per cent, after early gains evaporated. The UK’s FTSE 100 rose 0.9 per cent, boosted by economic support measures in the Budget speech.

The mid-cap FTSE 250 index, which is more skewed towards the UK economy than the internationally focused FTSE 100, ended the session 1.2 per cent higher.

Brent crude oil prices gained 2 per cent at $64.04 a barrel.



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UK listings/Spacs: the crown duals

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City-boosting proposals are not enough to offset lack of EU financial services trade deal



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