China's $1.9 Trillion Private Funds Industry Braces for Pain

(Bloomberg) -- China’s private funds industry is growing at the slowest pace in nearly three years, as shaky markets and a government crackdown on risk take a toll that’s expected to get worse.

Assets under management in the sector rose by 10 billion yuan ($1.5 billion) last month to 12.8 trillion yuan, according to data from the Asset Management Association of China. New issuance by funds that trade securities fell to the lowest level in more than a decade, according to simuwang.com. The slowdown comes after the industry more than tripled in size over three years.

Private funds, investment vehicles that can only have a maximum of 200 qualified investors, are finding it hard to lure buyers as the falling stock market dampens risk appetite, and after the government raised the qualification requirements, said Dexter Hsu, an analyst at Macquarie Capital Ltd. While clients should prepare for pain, the industry itself is heading for a shake-up, he added.

China's $1.9 Trillion Private Funds Industry Braces for Pain

“The boom in private funds is over, and the bust has just begun,” said Taipei-based Hsu. As fund firms dissolve or default, “investors have to absorb the losses themselves,” because regulators will prevent distributors such as banks from bailing out customers.

The perils of private funds, which include hedge funds, private equity and venture capital funds, were highlighted by this year’s most high-profile default, at Shanghai Fuxing Group. Zhu Yidong, the firm’s chariman, was taken into custody last month after Fuxing missed an estimated 18 billion yuan of payments to clients through private equity products. While the scale may be larger, it’s not an isolated case: the national asset management group said that as of Sept. 25 it couldn’t get in touch with 489 private funds, compared with 303 at the end of 2017.

China's $1.9 Trillion Private Funds Industry Braces for Pain

The funds’ struggles come as China’s equities enter a bear market and the economy, already under strain from a government deleveraging campaign, deals with the consequences of the trade war with the U.S. The benchmark Shanghai Composite Index dropped for a fourth straight quarter in the three months through September, the longest stretch of declines since the 2008 financial crisis.

China’s crackdown on shadow banking led authorities to issue rules in April that limited potential investors. The new guidelines included raising the minimum wealth eligibility threshold to 5 million yuan worth of financial assets from 3 million yuan.

“The industry will see a reshuffle in the coming two to three years, and many smaller players will go bankrupt,” said Xia Chun, chief research officer at Noah Holdings Ltd., which distributes private fund products to clients. Four out of five funds are having difficulty issuing new products and collecting enough fees to keep themselves going, he said.

Consolidation may be necessary in an industry where just 233 funds manage more than 10 billion yuan while over 6,000 oversee between 50 million yuan and 500 million yuan, according to data from the asset management association.

China's $1.9 Trillion Private Funds Industry Braces for Pain

The sector will be healthier after consolidation, Xia said, a view shared by Xu Xiaoqing, a partner and managing director at quantitative hedge fund Preston Group in Shanghai.

“China will likely loosen some rules in the future as it seeks to lure more foreign players,” she said. In recent months BlackRock Inc., UBS Group AG and Bridgewater Associates have been granted industry licenses. “In the longer term, there will still be demand for private funds with a competitive edge.”

To contact Bloomberg News staff for this story: Tian Chen in Hong Kong at tchen259@bloomberg.net;Jun Luo in Shanghai at jluo6@bloomberg.net

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With assistance from Editorial Board