Our Thoughts on the Mainland-Hong Kong Mutual Recognition of Funds

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Morningstar Analysts

The China Securities Regulatory Commission (CSRC) and Hong number of onshore asset management firms that could Kong’s Securities and Futures Commission (SFC) launched the participate in the MRF (Figure 1). Mainland-Hong Kong Mutual Recognition of Funds, or MRF, on July 1, 2015. Prior to this initiative, international investors could Out of the estimated 844 eligible funds, about 46% (388) are only invest in China’s onshore market through Qualified Foreign equity funds, 16% (133) are aggressive-allocation funds, and Institutional Investor (QFII) or Renminbi Qualified Foreign 10% (85) are aggressive bond funds (Figure 2), as categorized Institutional Investor (RQFII) schemes, while onshore Chinese by Morningstar. Additionally, 18 of the qualified funds are QDII fund investors could only gain access to global markets through funds and 30 are exchange-traded fund (ETF) feeder funds. Over Qualified Domestic Institutional Investor (QDII) funds. Through half of the 388 qualified equity funds have a large-growth- the MRF initiative, global investors will be able to invest in oriented investment style according to the Morningstar Equity eligible onshore Chinese funds via Hong Kong and, similarly, Style Box, followed by preferences for mid-growth and large- onshore Chinese investors will be able to gain access to eligible blend styles (Figure 3). Hong Kong-domiciled funds. With a net quota of RMB 300 billion (about USD 48 billion) each way, this regime is an Breakdown of the 103 Qualified Hong Kong-domiciled important step towards the progressive opening of China’s Funds capital market. The estimated 103 qualified Hong Kong-domiciled funds come A memorandum was signed by the CSRC and SFC that set from 20 fund companies with an aggregate fund size of USD eligibility standards on asset class, fund size, track record, 55.99 billion, or RMB 347.57 billion. The three fund companies investment mandate, and more. Based on these standards, we with the most funds qualified under the MRF are JPMorgan have screened 844 mainland funds and 103 Hong Kong- Funds (Asia) with 32 funds, BOCI-Prudential Asset Management domiciled funds that would qualify for the MRF. Here, we take a with 19 funds, and PineBridge Investments Hong Kong with nine closer look at what the MRF could offer and give investors a funds. From a fund size perspective, JPMorgan Funds (Asia), better idea of what is to come. Hang Seng Investment Management, and State Street Global Advisors (Chicago) are the top three fund companies with the Breakdown of the 844 Qualified Mainland Funds most AUM eligible under the MRF, with JPMorgan accounting We estimate that the 844 qualified mainland funds come from for almost one third of the eligible AUM (Figure 4). This reflects 69 fund companies, with an aggregate fund size of USD 331.9 the relatively concentrated nature of asset management firms in billion, or RMB 2,061 billion. The three fund companies with the Hong Kong that could participate in the MRF compared with most qualified funds to offer under the MRF are E Fund China. That said, it should be noted that the SFC-authorised Management with 34 funds, GF Fund Management with 32 universe in Hong Kong consists of almost 2,000 funds, many of funds, and China Southern Fund Management with 31 funds. which are UCITS vehicles domiciled in either Luxemburg or From a fund size perspective, China Asset Management, Ireland. As the MRF continues to develop and mature, there is Harvest Fund Management, and E Fund Management are the scope for asset managers to either re-domicile or set up top three fund companies with the most assets under separate Hong Kong-domiciled versions alongside their UCITS management (AUM). That said, the three firms account for only vehicles for onshore Chinese fund investors. around 5% each of total eligible AUM, reflecting the diverse

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Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Among the 103 Hong Kong-domiciled funds, about 68% are On the other hand, Hong Kong-based investors will be able to equity funds, followed by fixed-income funds at 22% and gain access to a diversified range of A-share and onshore fixed- allocation funds at 10% (Figure 5). The qualified funds domiciled income strategies managed by onshore specialists, an asset in Hong Kong offer diversified exposure, with most investing in class previously only accessible through limited QFII and RQFII Hong Kong, China, or the global market (Figure 6). Moreover, 10 quotas managed by offshore managers. Relative to their global ETFs are eligible, with most focusing on Hong Kong equity peers, onshore China equity managers tend to employ a range (Figure 7). of differentiated investment approaches and often invest without any references to an index (in fact, most funds do not What the MRF Means for Various Stakeholders have a prospectus benchmark). In addition, many tend to run For global asset managers, this represents a significant concentrated portfolios that are biased to certain sectors. While opportunity to tap into a market that has been a largely closed the onshore equity funds offer differentiated alternatives to the market with a population of 1.3 billion people looking for typically benchmark-aware offshore offerings, they may also additional ways to invest their growing savings pool. Prior to the come with higher degrees of risks. We have also observed that scheme’s announcement, we understand that a number of onshore China equity managers tend to be more momentum- asset managers had already established working groups to driven, which often results in high portfolio turnover and examine issues surrounding operations, tax, product strategy, therefore higher costs. According to our 2015 Global Fund and distribution. Furthermore, we expect a growing number of Investor Experience study, the asset-weighted median expense Hong Kong-domiciled funds as the scheme solidifies. ratio for equity funds domiciled in China ranges from 1.75 to 2.00%, which is more expensive than Hong Kong-domiciled For asset managers in China, the scheme provides the scope to funds, which range from 1.50 to 1.75%. A range of onshore use Hong Kong as a gateway to expand into international bond funds will also become available, some of which offer markets. Relative to their international peers, many Chinese income opportunities that are not accessible prior to the MRF. asset managers have more established track records on However, investors should be mindful of the risks associated onshore equities and fixed-income strategies and are well with internal gearing and have the scope to invest up to 20% of positioned to offer differentiated strategies for investors in Hong the fund in equities. This is a strategy often employed by Kong. onshore China managers.

Most importantly, investors can benefit from additional choice Again, we believe brand recognition may play a part for Hong and diversity that was not available to them previously. Through Kong-based investors when selecting onshore China funds, the MRF, mainland China investors can gain exposure to a large which would benefit Chinese asset managers who already have variety of funds that invest internationally and are managed by a presence in Hong Kong. experienced global asset managers. This is a big improvement compared with when funds offering global exposure were only Looking Forward accessible through the QDII scheme, which are managed by We expect more and more funds to become eligible under the onshore Chinese managers who may not necessarily be as well- MRF scheme as time progresses. Since 1 April 2014, 28 Hong versed in international markets investing. We believe Chinese Kong-domiciled funds and 671 China-domiciled funds have been investors would initially have the most interest in markets with launched that broadly satisfy the requirements to participate in which they are most familiar, such as Hong Kong equities, the MRF, notwithstanding the minimum fund size guideline. before gradually expanding into other asset classes. Moreover, While we welcome the MRF, it is not without its challenges. For we believe brand recognition may play a part for Chinese example, although fund investors are likely to benefit from investors when selecting offshore funds, and they may favour greater choice and diversity, it is unclear if a fund passport global or Hong Kong asset managers who already have joint scheme would necessarily lead to lower fees. venture operations or distribution relationships in the mainland.

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Nonetheless, the scheme represents a major development in the opening of China’s financial markets, and more countries may be accepted into the regime in the future. With 30 manager research analysts located across seven fund markets in the Asia-Pacific region, coupled with an extensive global database of managed investments, Morningstar’s expansive manager research coverage means that we are well placed to support financial institutions, investment advisors, and individual investors in making better-informed cross-border investment decisions.K

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Appendix

Figure 1 – Onshore China Fund Companies With Eligible Funds

Firm Name Number of Funds Total Eligible Fund % of Total Eligible for MRF Size (USD) Eligible AUM

E Fund Mgmt Co.,Ltd 34 16,626,751,845 5.01% GF Fund Mgmt Co.,Ltd 32 13,843,613,718 4.17% China Southern Fund Mgmt Co.,Ltd 31 12,728,523,697 3.83% ICBC Credit Suisse Asset Mgmt Co.,Ltd 28 14,403,395,282 4.34% Bosera Asset Management Co., Limited 26 12,614,753,499 3.80% Fullgoal Fund Mgmt Co.,Ltd 26 9,122,026,633 2.75% China Asset Mgmt Co.,Ltd 26 21,956,730,708 6.62% Harvest Fund Mgmt Co.,Ltd 26 19,667,649,551 5.93% CCB Principal Asset Mgmt Co.,Ltd 24 5,479,627,374 1.65% HuaAn Fund Mgmt Co., Ltd 23 6,676,547,855 2.01% Penghua Fund Mgmt Co.,Ltd 23 6,888,520,552 2.08% China Universal Asset Mgmt Co.Ltd 22 12,044,366,498 3.63% Yinhua Fund Mgmt Co., Ltd 22 9,767,310,985 2.94% Guotai Asset Mgmt Co.,Ltd 21 8,068,352,350 2.43% Invesco Great Wall Fund Mgmt Co. Ltd 21 7,952,171,519 2.40% China Merchants Fund Mgmt Co.,Ltd 21 6,087,002,830 1.83% Bank of China Investment Mgmt Co.,Ltd 21 6,327,777,824 1.91% China International Fund Mgmt Co.,Ltd 20 6,500,849,008 1.96% Da Cheng Fund Mgmt Co.,Ltd 19 8,675,212,588 2.61% Bank of Communications Schroders 19 5,231,527,998 1.58% UBS SDIC Fund Mgmt Co.,Ltd 16 3,613,053,970 1.09% Fortune SG Fund Management Co.,Ltd 16 5,724,920,515 1.72% Lion Fund Mgmt Co.,Ltd 16 6,695,297,611 2.02% Huashang Fund Mgmt Co.,Ltd 14 7,641,687,292 2.30% ABC-CA Fund Mgmt Co.,Ltd 14 2,341,523,352 0.71% Galaxy Asset Mgmt Co.,Ltd 14 3,434,945,143 1.03% Changsheng Fund Mgmt Co.,Ltd 14 2,625,438,717 0.79% HFT Investment Mgmt Co., Ltd 13 2,500,068,745 0.75% Rongtong Fund Mgmt Co.,Ltd 13 7,373,021,884 2.22% GTJA-Allianz Fund Mgmt Co.,Ltd 12 3,351,319,016 1.01% MANULIFE TEDA Fund Mgmt Co.,Ltd 12 3,216,357,357 0.97% Great Wall Fund Mgmt Co.,Ltd 12 5,141,414,532 1.55% CITIC Prudential Fund Mgmt Co Ltd 11 3,201,077,014 0.96% AEGON-Industrial Fund Mgmt Co.,Ltd 11 6,224,784,639 1.88% Everbright Pramerica Fund Mgmt Co.,Ltd 10 4,267,083,863 1.29% Franklin Templeton Sealand Fund Mgmt 9 1,739,080,819 0.52% New China Fund Mgmt Co.,Ltd 9 1,999,255,611 0.60% Orient Fund Mgmt Co., Ltd 8 2,387,068,891 0.72% Huatai-PineBridge Fund Mgmt Co., Ltd 8 2,304,182,070 0.69% HSBC JinTrust Fund Mgmt Co.,Ltd 8 1,232,416,204 0.37%

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Minsheng Royal Fund Mgmt Co.,Ltd 8 2,029,955,103 0.61% Morgan Stanley Huaxin Fund Mgmt Co., Ltd 8 1,594,351,941 0.48% Tian Hong Asset Mgmt Co.,Ltd 8 1,896,675,468 0.57% Chang Xin Asset Mgmt Co.,Ltd 8 3,268,804,588 0.98% Lombarda China Fund Mgmt Co.,Ltd 8 3,505,738,237 1.06% Baoying Fund Mgmt Co., Ltd 7 4,319,493,456 1.30% SWS MU Fund Management Co., Ltd 7 8,903,338,755 2.68% Zhonghai Fund Mgmt Co.,Ltd 7 1,608,662,288 0.48% China Post & Capital Fund Mgmt Co.,Ltd 7 6,087,656,062 1.83% Soochow Asset Mgmt Co.,Ltd 6 882,966,611 0.27% First-Trust Fund Mgmt Co.,Ltd 6 1,370,692,777 0.41% Wanjia Asset Mgmt Co., Ltd 6 1,100,974,507 0.33% Harfor Fund Mgmt Co.,Ltd 4 852,105,747 0.26% Golden Eagle Asset Management Co.,Ltd 4 498,818,303 0.15% Essence Fund Co.,Ltd 3 1,139,422,267 0.34% China Nature Asset Mgmt Co.,Ltd 3 788,965,260 0.24% First State Cinda Fund Mgmt Co. Ltd 3 714,776,072 0.22% CaiTong Fund Management Co., Ltd 2 174,450,652 0.05% Lord Abbett China Asset Mgmt Co.,Ltd 2 366,330,411 0.11% Ping An UOB Fund Management Company Ltd 2 184,374,569 0.06% YIMIN Asset Mgmt Co., Ltd 2 624,060,787 0.19% Orient Securities (China) Co., Ltd 1 265,633,546 0.08% Fuanda Fund Management Co.,Ltd 1 113,154,862 0.03% Goldstate Capital Fund Mgmt Co., Ltd 1 48,389,023 0.01% AXA SPDB Investment Managers Co.,Ltd 1 884,334,194 0.27% QHKY Fund Management Co.,Ltd 1 476,222,604 0.14% Western Leadbank Fund Mgmt Co.,Ltd 1 74,547,331 0.02% Yingda Asset Management Co.,Ltd 1 38,909,873 0.01% ChangAn Fund Management Co.,Ltd 1 428,116,719 0.13% Total 844 331,918,631,574 100.00% Source: Morningstar Direct; Fund Size as at 2015/3/31

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Figure 2- Breakdown of Eligible Onshore Funds by Morningstar Category

Broad Category Morningstar Category Number of Funds % of Total Eligible Group Eligible for MRF Funds Equity China OE Equity Fund 371 43.96% Allocation China OE Aggressive Allocation Fund 133 15.76% China OE Moderate Allocation Fund 70 8.29% China OE Conservative Allocation Fund 11 1.30% Fixed Income China OE Aggressive Bond Fund 85 10.07% China OE Normal Bond Fund 50 5.92% China OE Pure Bond 27 3.20% China OE Short-Term Bond Fund 32 3.79% Convertibles China OE Convertible Bond 12 1.42% Miscellaneous China OE Guaranteed Fund 35 4.15% QDII China OE QDII Asia-Pacific ex-Japan Equity 2 0.24% China OE QDII Global Bond 1 0.12% China OE QDII Global Equity 3 0.36% China OE QDII Greater China Equity 3 0.36% China OE QDII Sector Equity 6 0.71% China OE QDII US Equity 3 0.36% Total 844 100.00% Source: Morningstar Direct; Fund Size as at 2015/3/31

Figure 3- Morningstar Equity Style Box Breakdown for Eligible Onshore Funds

0.52% 0.26% 1.03% 0.77%

17.27% Large Blend 18.56% Large Growth

Large Value

Mid Blend 4.38% Mid Growth 3.61% Mid Value

Small Blend

53.61% Small Growth Small Value

Source: Morningstar Direct; Morningstar Equity Style Box as at 2014/12/31

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Figure 4 – Hong Kong-Based Fund Companies With Eligible Funds

Firm Name Number of Funds Total Eligible Fund % of Total Qualified for MRF Size (USD) Eligible AUM

JPMorgan Funds (Asia) Limited 32 17,446,580,526 31.16% Hang Seng Investment Management Ltd 3 9,761,084,775 17.43% State Street Global Advisors (Chicago) 2 8,576,003,001 15.32% BOCI-Prudential Asset Management 19 6,308,702,465 11.27% Schroder Investment Management (HK) Ltd 1 5,577,119,856 9.96% PineBridge Investments Hong Kong Limited 9 3,946,027,343 7.05% BEA Union Investment Management Ltd 9 1,879,905,667 3.36% iShares 2 483,912,311 0.86% HSBC Investments (Hong Kong) Ltd 2 481,933,548 0.86% BOCHK Asset Management Limited 2 430,675,628 0.77% Amundi Hong Kong Ltd 5 406,333,942 0.73% Zeal Asset Management Limited 1 233,664,171 0.42% Ping An of China Asset Management (HK)Co 1 90,502,613 0.16% BlackRock Asset Management North Asia Limited 1 87,617,853 0.16% Mirae Asset Global Investments (HK) Ltd 2 82,950,452 0.15%

CCB International Asset Management Ltd 1 79,581,584 0.14% First State Investments (Hong Kong) Ltd 1 66,800,000 0.12% CITIC Securities International Investment 1 53,656,303 0.10% Management (HK) Ltd Hai Tong Asset Management (HK) Limited 1 N/A N/A Principal Asset Management Co (Asia) Ltd 8 N/A N/A Total 103 55,993,052,038 100.00% Source: Morningstar Direct; Fund Size as at 2015/3/31

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Figure 5 –Breakdown of Eligible Hong Kong-domiciled Funds by Asset Class

10% 22%

Allocation Equity Fixed Income

68%

Source: Morningstar Direct as at 2015/3/31

Figure 6 –Breakdown of Qualified Hong Kong-Domiciled Funds by Global Category

Global Category Number of Funds ASEAN 1 Asia Pacific 7 Asia Pacific ex Australia 1 Asia Pacific ex Japan 8 Asia Pacific ex Japan ex Australia 5 Australia 1 China 20 China (Greater) 4 Europe 2 Global 20 Global Emerging Mkts 1 Hong Kong 19 India 1 Indonesia 1 Japan 4 Korea 1 Malaysia 1 Philippines 1

Insights From Morningstar's Manager Research Analysts July 2015 Talking Points

Thailand 1 United States of America 3 Vietnam 1 Grand Total 103 Source：Morningstar Direct as at 2015/3/31

Figure 7 – ETFs in Hong Kong Eligible for MRF

ETF Name Morningstar Category Fund Size USD

ABF Hong Kong Bond ETF EAA ETF HKD Bond 391,168,457 Hang Seng ETF EAA ETF Hong Kong Equity 5,625,972,090 Hang Seng H-Share ETF EAA ETF China Equity 3,993,670,029 Horizons Hang Seng High Dividend Yld ETF EAA ETF Hong Kong Equity 42,179,034 Horizons MSCI China ETF EAA ETF China Equity 40,771,418 iShares MSCI China EAA ETF China Equity 311,862,685 iShares S&P BSE SENSEX India EAA ETF India Equity 172,049,626 SPDR® FTSE Greater China ETF EAA ETF Greater China 31,365,730 Equity Tracker Fund of Hong Kong ETF EAA ETF Hong Kong Equity 8,544,637,271 W.I.S.E. - CSI HK 100 Tracker ETF EAA ETF Hong Kong Equity 48,935,805

Source: Morningstar Direct; Fund Size as at 2015/3/31