Across The Border
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Hedge fund-type investment products hurting rich mainlanders

Segregated accounts, for instance, slated for high-net-worth individuals and once viewed as money spinners, are entering a particularly tumultuous phase

PUBLISHED : Friday, 28 April, 2017, 6:03pm
UPDATED : Friday, 28 April, 2017, 10:22pm

Many wealthy mainland investors are being bluntly reminded that the value of their holdings in hedge fund-type products can depend on something as unpredictable as a mood swing by their asset manager.

Segregated accounts, for instance, slated for high-net-worth individuals – and once viewed as money spinners since making a killing on the equity markets – are entering a particularly tumultuous phase, amid an increasing number of disputes between disgruntled individuals and mutual fund houses.

The lack of any effective reporting mechanism also means investors can find it hard to tell the exact number of accounts they have, or what losses they are facing.

Segregated accounts are used by brokers to keep customer funds separate from the firm’s money.

This is done for various reasons, including creating a clear separation between the two so neither is used for the wrong purpose, and also to insure the money can be easily identified as belonging to customers in case anything happens to the firm, such as bankruptcy.

Many in China target only cash-rich individuals with at least 1 million yuan (US$145,000) to invest.

But anecdotal evidence now shows these accounts have become the latest hot bed of dereliction of duties and irregularities, to have plagued the already arcane A-share market.

Wu Yuan, an individual investor who bet on one segregated account product, is among thousands of victims who say he’s been badly burned.

“I thought hedge fund-type products were just a high-risk form of investment, only to find that the ethics of the fund managers actually carry the biggest risk for clients,” he said.

“Many have turned a blind eye to the regulations, putting clients’ money at risk.”

Before the stock market rout of mid-2015, mutual fund houses aggressively raised funds via segregated accounts to expand the size of their assets under management.

The products actively traded shares on leverage with a typical account having leverage ratios as high as 10.

A 10 per cent rise in the price of portfolio stocks could translate into a 100 per cent investment return, while a 10 per cent drop in prices could wipe out the investment value altogether.

I thought hedge fund-type products were just a high-risk form of investment, only to find that the ethics of the fund managers actually carry the biggest risk for clients
Wu Yuan, an individual investor who bet on one segregated account product

The strong stock market rally between October 2014 and mid-June 2015, which saw the key indicator jump more than 100 per cent, made segregated accounts the new darlings of the mainland rich, with an appetite for high risk .

But the boom-to-bust cycle, starting on June 15, 2015 which wiped US$5 trillion of value off the market in less than three months, forced the China Securities Regulatory Commission (CSRC) into action, stepping in to curb margin financing.

The leverage ratio of hedge fund-type wealth management products was capped at 2, with funds allowed to borrow as much as the capital equivalent of their net value, to fund share purchases.

But the new rule still failed to protect investors from suffering huge losses.

In the case of the product in which Wu invested, fund managers continued to buy shares after the value of funds crashed below the liquidation level.

“It was outrageous,” said Wu. “After studying the rules and regulations, we felt cheated by the fund managers.”

A group of five investors led by Wu is now negotiating with the fund management firm concerned for compensation after the Shanghai-based mutual fund company lost about 70 per cent of its investment value.

Wu said the affected investors are likely to sue, if they were not adequately compensated.

“These investment products lack transparency and their regulatory oversight is proving insufficient,” said Gong Zhenhua, a partner with Shanghai Ronghe Law Firm.

“These rich investors also appear to be ignorant of the nature of the funds and the legal conditions of the contracts they have signed, although many are well educated.”

Many, however, have continued on the investment rampage, flocking to the stock market during the ongoing bull run, regardless of the fundamentals.

But in China’s casino-like stock market, it’s the individual investors who have often been left to bear the brunt of the losses, as the boom-to-bust environment continues.

“The previous round of market gyrations were not enough to teach the country’s greedier investors a lesson,” said Haitong Securities analyst Zhang Qi.

“They were impressed by the handsome returns generated by segregated accounts – but many forgot that the risks they carry are super high, if stock prices were to fall.”

The sorry segregated saga is just the latest issue to have left China’s 100-odd mutual fund companies red-faced.

As of March, around 40 guaranteed funds, for example, had posted investment losses with net asset values falling below their offer price of 1 yuan (HK$1.1) per share.

The funds, which at least guarantee the repayment of principal, are normally focused on bonds that offer low but stable yields.

The woeful performance of the guaranteed funds follow a fundraising spree last year, when 80 new products hit the market, as investors looked for lower-risk investment tools in a slumbering stock market.

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