Shock and tears: behind Vanguard's retreat from China market

New York

VANGUARD Group staff who dialled into a video call from their desks on the 40th floor of the Shanghai World Financial Center last month were expecting a morale-boosting speech from regional head Scott Conking on how the US fund giant would tackle the Chinese market after years of preparation.

Instead, Mr Conking said the US$7 trillion money manager was abandoning its push for a mutual fund licence. The firm would rely on an advisory venture with Ant Group to maintain a presence in China, he said via video from the same Shanghai office, where he was visiting for the first time.

The 30-odd employees were in shock. More than 10 staff were let go right after Mr Conking finished speaking, said people familiar with the matter. One employee burst into tears, the people said, asking not to be identified as the information is private.

Yet behind the seemingly hasty retreat were years of scrutiny by Vanguard's top management on whether its low-cost model works in China, the people said. The conclusion, at least for now, appears to be no, and serves as a cautionary tale for other global asset managers eyeing China's US$13 trillion wealth market.

A representative for Vanguard declined to comment.

While there had been some signs of Vanguard's shrinking ambitions in Asia last year, the firm was still expected to apply for a fund licence in China, seen as crucial for growth in the burgeoning wealth market. Vanguard, like other foreign players, was given the green light to apply last April, removing the need for a local partner.

For some former Vanguard executives, the sky was once the limit for China. Former Asia head Charles Lin saw potential to increase assets to about US$5 trillion given the pace of wealth accumulation in the world's second-biggest economy.

"We're in this for a hundred years, not five years," Jim Norris, then head of Vanguard's international business, said in a May 2018 interview. "And we feel very confident that over time we'll be able to get to that scale" to make money.

The enthusiasm for China began to wane under Tim Buckley, who took over as chief executive officer in 2018, sources said. Under his direction, the new finance chief started quarterly profit appraisals of each business line and region, marking a pronounced shift from his predecessor Bill McNabb.

Despite the massive potential in China, Vanguard did not apply for a fund licence right away. The company raised more eyebrows in August when it announced plans to close operations in Hong Kong and Tokyo, affecting 70 jobs. At the time, Vanguard said that "current industry dynamics" do not support its low-cost model, while citing the "considerable opportunity" in China.

The US firm pulled back further in October by returning about US$21 billion in managed assets to government clients in China. It also lost a mandate to run US$590 million in Taiwan due to weak performance.

Cost concerns

Even as China's economy began to pull out of the pandemic last year, Vanguard's concerns about costs, distribution, staffing and regulations were mounting, the people said.

It took the firm more than a year to find a strong candidate for a chief compliance officer, a requirement for the licence, the people said. The job offer was rescinded about a month before Mr Conking's announcement, they said.

Regulations were also an issue. While China has opened the door for foreign licences, it has tightened requirements, particularly for global players. The regulator asked Fidelity Investments and Neuberger Berman in November to pledge liquidity support for the licences they were seeking. That raised concerns about additional capital costs for Vanguard, the sources said. A year after the opening, only BlackRock has obtained a fund licence.

A November report by China International Capital said foreign-controlled or wholly-owned asset managers may grab as much as 15 per cent of the market from local rivals over the next decade. Yet, they need to overcome barriers including a lack of distribution channels, along with the Chinese firms' first-mover advantages, the report found.

Break even

Foreign asset managers need at least 50 billion yuan (S$10.3 billion) in assets to turn a profit, CICC analysts led by Yao Zeyu estimated. Vanguard would need more, given its rock-bottom fees that have driven its growth in North America.

Still, Mr Lin's team estimated its wholly-owned mutual fund business could reach 100 billion yuan in assets within five to seven years, enabling it to break even, the people said. The scenario assumed the firm would sell active and passive funds, bolstered by the joint venture with Jack Ma's Ant, set up in 2019.

Vanguard may have realised that "it won't help much" even if it launched its own funds in China given the costs and its lack of competitive advantage, said Bloomberg Intelligence analyst Francis Chan.

Decades since Wall Street firms first entered the China market, they remain dwarfed in the asset management space by domestic banks and brokerages. Funds backed by international firms raised less than half the US$967 billion haul of their 100-plus Chinese rivals in the first eight months of 2020, data compiled by Morningstar and Bloomberg showed.

Z-Ben Advisors, a Shanghai-based consultancy, last year lowered its forecast for foreign companies' market share in China's mutual fund industry by 10 percentage points to just 15 per cent by 2030.

Without a licence in China, Vanguard will rely on its joint venture with Ant, which has doubled its client base in just two months. Assets under management jumped 60 per cent from the end of last year to 6.9 billion yuan as at Feb 28, a source said. That puts the business on track to reach an estimated 10 billion yuan break-even point well ahead of its five-year target, the people said.

While Ant's one billion Alipay users hold huge potential, its recent launch of an open advisory platform to other fund managers may dilute resources for the Vanguard venture, Bloomberg Intelligence's Mr Chan said.

"It's easy to make an application, but committing all the resources to make things work is much more difficult," he said. BLOOMBERG