China fund panic spurs risky backtrack on mark-to-market pricing
By valuing assets using amortised costs, investments can appear to rise gradually over time, but the method can also cover up price swings or defaults
CHINA’s banks and asset managers are turning to an old, yet potentially risky, accounting manoeuvre to attract buyers to their investment funds, after a rout in the bond market triggered waves of redemptions last year.
The wealth management units of banks such as Industrial and Commercial Bank of China (ICBC) and Postal Savings Bank of China are rushing to sell new funds that value most assets based on adjusted costs rather than current market prices, masking day-to-day volatility.
Mutual fund firms also launched their first batch of products this month using a similar method.
China’s asset managers are seeking to stem an exodus of clients by resorting to the so-called amortised cost accounting method, which has been tightly restricted in recent years as regulators have sought to bring more transparency to the market. Officials are now showing more tolerance for the method following the sharp bond decline.
“The large number of amortised-cost products being launched currently smacks of market rescue,” Shanghai-based consultancy Financial Regulation & Law wrote in a Feb 3 report. More than 20 firms have responded to the easing by launching new products using this type of valuation, said a China Minsheng Banking Corp report on Feb 11.
Similarly, five mutual fund firms have launched so-called mixed-valuation funds for the first time. Penghua Fund Management Co alone raised about eight billion yuan (S$1.56 billion). Representatives for Penghua and the ICBC and Postal Savings Bank units didn’t immediately reply to requests for comment.
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The new funds aren’t without risks. By valuing assets using amortised costs, buyers can usually expect to see their investments gradually rise over time as the underlying bonds get closer to maturity.
Masking price swings
Yet the method can also cover up wild price swings or defaults ahead of repayment, and undermines China’s push to wean investors off seemingly guaranteed fund returns. The accounting method is often used in the US on assets like money-market funds held to maturity, but less so on longer-term offerings such as the one- to three-year terms typical for these China funds.
“The wealth management firms are adjusting strategies after market conditions shifted”, seeking to shelter clients from market swings after the redemptions, said Zhou Yiqin, president of GuanShao Information Consulting Center, which specialises in financial regulations.
Investors’ abrupt shift to riskier assets, including stocks late last year, helped spur the biggest decline in China’s short-term government bonds since mid-2020, fuelling a spiral of redemptions. Regulators even asked banks to report on their ability to meet short-term obligations, Bloomberg reported in November.
The outstanding balance of wealth management products shrank by more than two trillion yuan last year and dropped a further 300 billion yuan in January, partly driven by the redemptions, according to estimates by China International Capital Corp (CICC). The industry could face another wave of withdrawals this month and the next, as about 12 per cent of the products are still under their 1-yuan starting price, analysts led by Wei Lulu wrote in a report on Feb 2.
The correction “exceeded people’s expectations”, as investors’ anticipation of stable returns in these fixed-income focused products was dashed by the declines, the analysts wrote, citing surveys of wealth management firms. The increasing share of more volatile bonds in these funds and their lack of liquidity made the expectation gap “particularly alarming”.
To protect against more declines, the new products tend to hold higher-rated bonds of similar durations to maturity, which could prop up demand, said CICC.
Regulatory approval
Mutual funds applied for these so-called mixed-valuation products in the first half of last year, but didn’t get approval as regulators weren’t encouraging the method after tightening rules for the industry, said the Financial Regulation & Law report.
The government changed tack after the bond rout made it clear that amortised-cost accounting could help prevent massive redemptions and protect the debt market. At the same time, officials are trying to root out implicit guarantees that fuelled the industry’s expansion, but also increased risks.
The use of the amortised-cost method is restricted to closed-end products that hold qualified bonds to maturity. The China Banking and Insurance Regulatory Commission and the China Securities Regulatory Commission didn’t immediately reply to requests seeking comment.
Money managers are well aware of the possibility that these products may rekindle investor expectations of can’t-miss returns. “There’s still the risk of fluctuation in fund units’ net value,” Penghua Fund said in its prospectus. “Amortised-cost valuation doesn’t equal principal guaranteed.” BLOOMBERG
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