SHANGHAI/HONG KONG (Reuters) - Global fund managers are ramping up their presence in China, aiming to be well ahead of next June's inclusion of mainland-listed stocks into MSCI's benchmark index that is set to boost investment into the economy's $8 trillion equity market.
Wells Fargo Asset Management, Neuberger Berman, Fidelity International and Robeco are among fund houses sharpening their stock-picking skills in mainland "A" shares and hiring staff in China to get a first-mover advantage before the rebalancing triggers a flood of passive index-tracking funds to that market.
Anthony Cragg, Colorado-based senior portfolio manager at Wells Fargo Asset Management, visited China just two weeks after MSCI decided on June 20 to include 222 Chinese big-caps into its Emerging Markets Index.
MSCI will start phasing in Chinese shares from June 2018 but Cragg is already in search of the country's "future blue chips".
"It's a game changer for China investment because one year from now passive funds have to buy. They have no option. Active funds can move between now and then," Cragg said.
Active funds can select the companies they think have better growth potential and add them to their China-focused funds now. Cragg, who manages $2.2 billion in several funds - including one dedicated to China - said A-shares account for roughly 18 percent of his China Equity Fund, but he wouldn't be surprised to see the weighting rise to a ceiling of 25 percent within a year.
Some fund houses are building up their domestic businesses to deepen knowledge and expertise. Neuberger Berman is relocating its Chinese equity research from Hong Kong to China.
More than 20 global managers, including Fidelity, Aberdeen Asset Management, Bridgewater Associates, Mirae Asset, Vanguard, Allianz and Schroders have set up wholly-owned investment subsidiaries in China, and the numbers will rise to at least 30 by the end of 2017, according to fund consultancy Z-Ben Advisors.
In addition to strengthening their on-the-ground research capabilities, these units are being used to grow onshore fund businesses in China, with an escalation of activity seen over the past six months, the consultancy said.
"When the markets are as big as they are in China, the big global investors have to become local investors...that's how you can get information, that's how you can create information advantage," said Nick Hoar, head of Asia-Pacific at Neuberger Berman, noting huge growth potential for foreign firms.
"Apparently the powers are shifting, and the flows are shifting toward this market," Hoar said, adding that large pension plans will have to slowly allocate directly to Chinese local assets.
Dutch asset manager Robeco has set up a wholly-owned subsidiary in Shanghai to beef up it research capabilities. Its China research team will focus on A-share investment research and will provide advice to Robeco portfolio managers globally.
The rising tide of investment is good news for Chinese markets but the risk for these fund managers is that they may be over-estimating investor appetite for the overvalued and opaque Chinese stock markets. The head start by hedge funds and active money managers could elevate valuations for passive investors.
China's CSI300 index .CSI300 trades at 20.9 times current earnings, among the highest such valuation in Asia.
UBS Securities estimates passive and active foreign investment flows into China from MSCI's inclusion will be about $14 billion, less than MSCI's own projections of $17-18 billion in initial flows. These estimates are roughly based on the $1.6 trillion that tracks the emerging markets index.
Although the inflows will be around just a quarter of China's daily trading turnover, foreign ownership in Chinese shares will rise steadily from 4-5 percent, said UBS analyst Gao Ting.
Chinese asset managers are also smelling business opportunities.
Shanghai-based MegaTrust Investments is launching its first offshore fund to help foreign investors buy A-shares guided by local expertise.
Charlie Chen, chief investment officer at MegaTrust, reckons generating sustainably strong returns in A-shares against the benchmark index will be challenging and his new fund should help global investors do that.
Shenzhen-based Academia Capital Management is also riding on the MSCI wave with plans to launch an offshore fund that seeks absolute returns using quantitative strategies.
Passive investors are already increasing their exposure to A-shares using China-focused exchange-traded funds (ETFs).
KraneShares Bosera MSCI China A ETF (KBA.P), a New York-listed, China-dedicated ETF, has seen its assets under management explode more than 10-fold this year to roughly 1.3 billion yuan, partly driven by bets from U.S. investors that Chinese shares would gain MSCI inclusion.
"Compared with other emerging markets, A-shares have always been under-owned by U.S. investors. Once their interest is lit up, there's a big room for A-share allocation to increase," said Wan Qiong, fund manager at Bosera.
"I'm optimistic that foreign capital will continue to flow in steadily in the second half."
($1 = 6.7995 Chinese yuan)
Editing by Vidya Ranganathan and Jacqueline Wong