China IPO funds threatened as regulators mull share sale ban

[HONG KONG] China's consideration of a suspension on initial public offerings is threatening hybrid funds that rely on them to boost returns.

The open-ended funds typically buy short-term debt and are also allowed to purchase equity, which they do after winning allocations in lotteries for IPOs. Almost all companies going public this year have jumped by the 44 per cent limit on the first day, compared with the 3.5 per cent yield on AAA commercial paper.

While that helped boost fund returns to more than 10 per cent annualised in the first half, any IPO suspension would drag down their performance, Huachuang Securities Co says.

The IPO funds flag tensions in China's financial system, where capped deposit rates are pushing savers into ever riskier products. The number of the hybrids has jumped to over 200 from almost zero last year and they now manage total assets of about 2 trillion yuan (S$434 billion), bigger than Malaysia's economy, Huachuang estimates.

They have displaced equity mutual funds as the most popular investments in the country, according to a June 17 report from China International Capital Corp.

"If IPOs stop, returns from those IPO funds will not be attractive from just investing in short-term fixed income assets," said Gao Qunshan, an analyst at Tianfeng Securities Co. "In that case we expect investors would withdraw from those funds and put their money where returns are higher."

Regulators are considering suspending IPOs to stabilise the country's stock market, people familiar with the matter said Monday. The Shanghai Composite Index jumped 5.5 per cent Tuesday, after last week capping its worst two-week rout since 1996.

Authorities are considering a delay in the IPO of China Nuclear Engineering Corp, other people familiar with the matter said Tuesday. There is a queue of 552 companies waiting for approval after filing initial offering applications, according to data from the CSRC website.

"While it's too early to tell what will happen, there's a lot of policy uncertainty right now that could affect the IPO funds," Tianfeng's Mr Gao said.

IPOs have been surging after regulators put pressure on companies to keep prices low. While policy makers made no official announcement about a valuation ceiling, data compiled by Bloomberg show that virtually no companies in China are going public at prices of more than 23 times their earnings per share. Guotai Junan Securities Co, China's largest brokerage by revenue, leapt 44 per cent on its first day of trading in Shanghai Friday, even as the broader index sunk 7.4 per cent.

"If IPO issuance does indeed stop for a while, we expect it to be momentary and we would shift more allocation to fixed income assets," said Liu Fangzheng, Shenzhen-based portfolio manager at Penghua Fund Management Co.

One of the company's hybrid funds has an annualised 10.3 per cent return since it was established in March, Mr Liu said. In addition to IPOs, the firm's hybrids invest in fixed-income assets including commercial paper and negotiates to earn higher interest on money it deposits at banks.

The fund typically sells the newly issued shares once they stop increasing by the daily 10 per cent limit, Mr Liu said.

Guotai Nongyi Hybrid Fund, managed by Guotai Asset Management Co., has had a 14.5 per cent annualised return this year, according to its site. When it lacks allocations or when IPOs hit a dry patch, it invests in money markets and equity, according to fund portfolio manager Zhang Yige.

While large withdrawals from IPO funds are unlikely so long as returns stay above standard fixed-income and wealth- management products, any IPO ban would threaten performance, according to Huachuang Securities.

"Overall, returns of the IPO funds are likely to be lower than we previously expected," analysts at the brokerage led by Qu Qing wrote in a report Tuesday.

BLOOMBERG