Stock sale ban likely to backfire

PUBLISHED : Monday, 02 June, 2008, 12:00am
UPDATED : Monday, 02 June, 2008, 12:00am

In an attempt to prop up sagging mainland stock prices, the China Securities Regulatory Commission is ordering fund managers not to sell shares. Its tactic could backfire royally.

On Friday, the CSRC told fund managers they must act with 'political sensitivity'. It instructed them that market stability is their 'number one responsibility' and threatened any who disregard the warning, for example by selling large holdings of stock into a falling market, with 'administrative punishments'.

Never mind that the main responsibility of fund managers is not to maintain market stability but to generate decent returns for investors at acceptable levels of risk. This is simply a bad move.

Of course, fund companies are obliged to comply with local regulations. Anyone disrupting the efficient and orderly operation of the market by attempting to manipulate stock prices for personal gain richly deserves to be stamped on.

But it should not be the job of fund managers to support ill-considered government policies, especially if that support could disadvantage their investors. If a portfolio manager thinks the market is expensive and that prices will fall significantly, he should be free to reduce his exposure without official interference.

Still, by meddling in the market, the CSRC is being true to form. Beijing pays lip service to the virtues of market forces, but in reality officials still believe that the state should direct prices.

And with the Shanghai Composite Index down 44 per cent from its October high (see the first chart), officials think the slide has gone far enough. In recent weeks, Beijing has come out with a series of measures intended to boost prices, although with little success. Now the CSRC has resorted to arm-twisting fund managers not to sell.

To officials, this looks like an effective solution to their problem. After all, even though assets under management in mainland mutual funds dropped 20 per cent in the first quarter (see the second chart), with some 2.6 trillion yuan (HK$2.92 trillion) remaining, mutual fund assets are worth almost a quarter of the mainland stock market's free float. That means mutual fund managers are influential players. If they can be cowed into holding on to their stocks, reasons the CSRC, perhaps the market's decline can be halted.

Such arm twisting is ill-advised. If fund managers are prohibited from selling stocks, then they will simply stop buying.

At the moment mainland mutual funds typically hold between 5 and 20 per cent of their assets in cash, with the rest invested in equities. Yet a quick glance at data compiled by Shanghai-based research house Z-Ben Advisors shows that during the first quarter assets under management typically fell faster than stock prices, indicating that funds are facing heavy redemptions.

If fund managers are worried they will run into problems selling stock, the sensible response would be to sell as much as they can without incurring official wrath while keeping as much money in cash as possible to cover redemptions by investors.

Certainly they will be reluctant to buy without the freedom to sell again. And without fund managers buying, the market will have even less support than before. So instead of boosting prices, the CSRC's latest attempt to shore up the market is likely to have the opposite effect, weighing even more heavily on the market.

More broadly, for a market's price discovery to be efficient, participants must have the liberty to buy and sell as they choose. If they are stripped of that liberty, the market will no longer be efficient. That might please Beijing, but it is ordinary investors who will pay the price.