Summary:
At the end of 2021, Chinese mutual funds managed 25 trillion yuan and had over 9,288 funds. While the asset under management (AUM) is only 1/10 of that of the US mutual fund industry (34 trillion USD), the number of funds has already surpassed that of the US (8,840). The rapid growth of the Chinese mutual fund industry is primarily driven by new issuances, resulting in the fact that on average, a manager oversees 2.7 funds. One of the main factors contributing to this rapid fund issuance is the unreasonably high custodian fee that banks charge, which is 0.25% per year. Since banks are the primary sales channel for mutual funds in China, funds need to compete for the limited sales capacity of banks. Mutual fund companies can provide an extremely cost-effective incentive to issue a new fund that uses the bank as the custodian. This is cost-effective for the fund company because issuance costs are low and lucrative for banks. After all, once issued, the custodian bank cannot be changed, allowing the bank to receive all future custodian fees, which are high and almost cost-free. In exchange, the bank will give favorable allocation for the new fund. This distorted incentive structure results in managers overseeing an excessive number of funds, and managers may show favoritism among funds. We find that managers tend to favor new funds, with new funds outperforming old funds by an average of 1.5%-2% per year. Using a staggered DID approach, we show that when a fund manager issues a new fund, the performance of old funds declines significantly. Managers tend to favor new funds because investors' flow-return relationship exhibits a convex shape, and the flow-return relationship is more sensitive for new funds. Suppose a manager can generate a 10% return for the two funds under management or 15% for one and 5% for another. Convex flow-return relationship means that the latter can attract more flow, and new funds being more sensitive means that the 15% return will go to the new fund. We identify one possible channel that generates the gap between old and new funds: Managers allow new funds to front-run old funds. Using the holding data, we show that the position changes of new funds can predict the position changes of old funds in the next period, but not vice versa. These findings provide valuable insights into the regulation of the Chinese mutual fund industry and investor protection. Excessive fund issuance can lead to unfair dealing among clients. Given that the high custodian fee is a root cause, we recommend that Chinese regulators marketize the custodian market and allow competition to drive the fee to a lower level. According to Cullinan and Blin (2005), the average custodian fee in the US was only 0.025% in 1997, which is 1/10 of that in China in 2021.
叶帅, 张劲帆, 郑凯轩. 中国新基金过度发行之谜和投资者保护[J]. 金融研究, 2024, 531(9): 171-188.
YE Shuai, ZHANG Jinfan, ZHENG Kaixuan. Excessive Issuance of New Funds in China and its Implication on Investor Protection. Journal of Financial Research, 2024, 531(9): 171-188.
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