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    This paper will discuss the operation of unlisted managed funds in Australia, how it affects the Australian share market and what experience can be shared by China for developing its managed fund industry.
    
    1.What are unlisted managed funds?
    
    Managed funds are pools of money from individual investors and are held in trust by designated trustees. These pool of money are managed by a responsible entity (called the fund manager) and used to buy assets (such as listed shares and real properties) according to the investment objective of each fund. A small number of managed funds are listed in the stock market but, by far, most of managed funds are unlisted. For the latter, buying and selling prices are set by the respective fund manager according to the latest valuation of the investment assets.
    
    In Australia, retirement and pension funds are the dominant single sector of the managed fund industry. They constitute approximately 52% of the total investment in managed funds. The remaining managed funds are investment by nature.
    
    2.Diversity of unlisted managed funds
    
    In a matured market like Australia, there are literally thousands of managed funds available in the market and they are provided by about 40 major licensed fund managers. In addition, there is an equal number of smaller players. At the time of initial offering to the public, fund managers will publish their objectives, expected rate of returns and asset allocations and such information is contained in a prospectus.
    
    A typical fund manager would have the following funds in his product list:
    
    (a) Conservative Fund: To provide a regular income stream while maintaining and potentially increasing the value of the capital.
    
    (b) Balanced Fund: To provide a balance of income and capital growth returns from investments in cash, fixed interest and Australian companies.
    
    (c) Diversified Fund: To provide consistent returns with low volatility by investing across most major asset sectors including international equities.
    
    (d) High Growth Fund: To provide capital growth by investing in a diversified portion of Australian and international companies.
    
    (e) Imputation Fund: To provide long term capital growth with some tax-effective income by investing in a broad selection of Australian companies.
    
    (f) Geared Share Fund: To magnify returns from capital growth by borrowing to invest in blue chip Australian companies.
    
    (g) Property Securities: To provide capital growth and income from a broad selection of liquid property investments listed on the stock market.
    
    (h) Income Fund: To provide a consistent monthly income by investing in a broad selection of high quality commercial mortgages, money market securities and cash.
    
    (i) Developing Companies Fund: To provide capital growth by investing in small listed companies.
    
    (j) Global Share Fund: To provide capital growth by investing in a broad selection of listed companies around the world.
    
    There are numerous other funds which are offered by fund managers in the market to meet different investment objectives of investors.ªªª¤
    
    In the early days, managed funds invested in listed shares (local or international), bonds and cash or a mixture of them. As the market developed, new managed funds extended investments to cover real properties, incorporated borrowing strategies or linked performance with a market index. As the market further matured, derivative products were introduced to the market including capital guaranteed products, 100% geared and protected portfolios and hedged funds.ªª
    
    3.Why should investors pick managed funds instead of direct shares or real properties?
    
    Major benefits of investing via managed funds are:
    
    (a) for a fee, investors would be able to get the service of a professional manager and would become part of a ¡°big fish¡±. Theoretically, the expertise of the fund manager should result in a higher return for the individual. Fund managers are always assisted by their research team;
    
    (b) investors would be able to achieve diversification which means spreading of risk over a large number of stocks;
    
    (c) investors can allocate their investment across a range of asset classes (i.e. real properties, shares, cash etc) according to their personal preference. Hence investors with lower risk tolerance can invest in balanced funds and investors with a stronger risk appetite can go for growth funds. Such a degree of diversification would not be possible for average investors who have a small capital;
    
    (d) investors can use various techniques to reduce market risks, such techniques include dividend reinvestment (i.e. compounding of interest), cost dollar averaging and blending of funds.
    
    4.Distribution and marketing of managed funds
    
    Fund managers are product providers and have a supporting team of technicians and market analysts. Usually fund managers have their own client advisors who promote their in-house products and they also have a team of business development managers who promote their products to independent client advisors. Independent advisors have the advantage of picking and choosing products from different fund managers that suit their clients most.
    
    As an incentive to promote their funds, fund managers pay an upfront fee and a trailing commission to client advisors who sell their products. Business development managers compete for the business of independent advisors and sometimes provide marketing incentives and rewards in order to gain a closer relationship with the advisors.
    
    5.Performance of fund managers
    
    The success of a managed fund is measured by its historical performance and its fund size.
    
    Historical performance is usually expressed as an average annual rate of return over a certain period of time, say 1, 3 or 5 years. Fund sizes are published by fund managers periodically and a measure of the net fund growth or shrinkage over a certain period can be the best thermometer for the mood of their investors towards a fund.
    
    As a rule of thumb, about 70% of fund performance is attributable to asset allocation and about 30% arises from stock selection. A minor portion comes from market timing.
    
    In Australia, the performance of managed funds is monitored by a number of independent rating agencies. They rate managed funds either by giving a certain number of stars (5 stars being the highest rating) or a recommended status (such as strong hold, hold, neutral or sell). The basis of rating include the manager's skills and substance, consistence in performance, stability in the management team and the fund size.
    
    In a bull market, the performance of fund managers is usually expressed as a net rate of return after fees. This is often over and above deposit rates and the consumer price index. In a bear market where investment returns of a managed fund could be negative, performance is usually measured against a benchmark market index.
    
    6.Style of fund managers
    
    There are many contrasting ways to describe fund managers and the three most common ones are given below:ªª
    
    (a) Growth versus Value: A "growth" manager looks for high earning growth in the future and sustained growth which is expected to be faster than the economy.
    
    A ¡°value¡± manager looks for bargain and buys stocks which are perceived to be trading at a discount to their book value. ¡°Value¡± managers base their work on fundamentals such as the rate of return and P/E. If a manager adopts both growth and value philosophies at different time, he is called a GARP manager which stands for ¡°Growth at Reasonable Prices¡±.
    
    (b) Active versus Passive: Managers can actively selective stocks on the basis of their analysis and successful fund managers who consistently outperform market indices over time have demonstrated their capacity to add value by active management. Passive managers tend to construct portfolios within their class so as to mirror some stock market index. Performance of passive managers would be the same as the index.
    
    (c) Top-down versus Bottom Up: When a fund manager determines his long term asset allocations and leaves the picking of stock to specialist managers, such a process is termed top down analysis. Broad economic factors such as economic growth rate, inflation, exchange rates etc will affect the view of selection. Bottom-up analysis concentrates on determining expected market performance of individual shares and focuses on stock picking only.
    
    7.Regulating and supervision of the issuance of managed funds
    
    In Australia, the operation of unlisted managed funds is highly regulated by a single government department known as Australia Securities and Investments Commission (¡°ASIC¡±). The following areas are highly controlled and supervised by ASIC:ªª
    
    (a) licensing conditions for fund managers;
    
    (b) details and product features to be included in the prospectus;
    
    (c) level of training required for fund managers;
    
    (d) consumer protection regulations which include the disclosure of fees and benefit of the manager and any conflict of interest;
    
    (e) appointment of an external body for the resolution of any disputes between investors and fund managers and any complaints against fund managers;
    
    (f) investigation of frauds.
    
    As the industry is overseen by one government department, there is no confusion about which department is responsible for what area.
    
    In addition, there are a number of laws which affect the marketing of managed funds. They include Financial Transaction Report Act (i.e. money laundering control law), Trade Practices Act (to protect consumers), Common Law etc. All fund managers and stock brokers in Australia have a Compliance Manager who is responsible for ensuring that all government regulations have been complied with by reviewing all prospectus, marketing procedures and promotional materials before a product is released.
    
    8.Impact of managed funds on local stock market
    
    (a) It is believed that in the long run, small investors would have little chance to make profit by trading daily in the stock market based on third-hand information reported in newspapers or given by stock brokers. Managed funds provide an orderly medium for investors to channel their capital into different asset classes especially the stock market. They are ideal for people who know very little about the stock market and do not know which stocks to pick. Managed funds are also suitable for substantial investors as they can reduce specific risk by diversification.
    
    (b) In Australia, employers are required by law to contribute at least 9% of the income of their employees to their respective retirement funds. By far, the majority of employees make their contribution to retirement managed funds called superannuation funds. This pool of funds is very substantial and is growing everyday. The proportion of individual superannuation funds which has been invested in the stock market depends on individual's asset allocation. Retirement funds are long term savings and preserved until the age of retirement. They provide a channel to direct national savings to supporting local industries.
    
    (c) Historically Australia' s stock market has been trading steadily upwards over the last 22 years. Whilst its movement is correlated to the ups and downs of the global economy, it has avoided wild swings at times of crashes experienced by other international markets. (Please refer to the attached Global Sharemarkets Chart.) One of the main contributing factors is that the market is dominated by institutional traders (i.e. fund managers and investment managers) It was estimated that 75% of the daily trading volume are attributed to overseas and local institutional traders. Individual investors only make up the remaining 25% of the daily trading volume. In times of volatility, professional fund managers usually behave more calmly and avoid panic selling as their investment decisions are backed up by research. Investors fully understand the strategy that investments via managed funds are meant to be long term and thus managed funds provide a stablising factor for the stock market.
    
    (d) Another positive impact of managed funds to the society is that fund managers and investment advisers have developed into two new industries within the finance sector. Degree courses in finance have become very popular for undergraduates. More and more graduates aim at taking up fund managers and client investment advisers as their careers.
    
    9.Latest development of unlisted managed funds
    
    We have mentioned earlier that a number of innovative investment tools have been created in Australia, such as equity linked capital guaranteed products, 100% geared and protected portfolios and hedged funds. Such products are suitable for more sophisticated investors.
    
    Another development is the proliferation of master trusts and wrap accounts. Master trusts and wrap accounts are platforms for investors to diversify and to hold their investments and at the same time enjoy a more favourable scale of fees. These platforms also provide investors with a wide range of choices of funds from various managers.
    
    Margin lending against a portfolio of managed funds in a master trust (instead of a portfolio of direct shares) has become a new trend. As managed funds are usually less volatile in prices, this strategy reduces the chance of margin calls.
    
    Recently we have also seen the promotion of ¡°Manager of managers" funds. Basically these managers conduct research on the performance of other fund managers and not on individual shares and their funds are made up of a combination of selected third-party funds. We have also observed a slow reduction in management fees and administration fees charged by fund managers. This was driven by strong competition, a wide-spread use of internet trading as well as an increased demand from consumers.
    
    10.What will be the future direction for unlisted managed funds?
    
    Three trends have been identified:
    
    (a) Fees charged by fund managers will continue to fall due to the abovementioned market forces. There is still a gap between the management fees charged by Australian fund managers and their counter-parts in USA.
    
    (b) As a market practice, management fees are being charged by fund managers regardless of the performance of the fund.
    
    There is a demand from investors to link fees with performance. In other words, fund managers will charge a low basic management fee and if a certain benchmark in performance is reached, extra fees will be charged by the manager. This fee structure will certainly attract investors.
    
    (c) The Australian Stock Exchange is considering ways to attract the listing of unlisted managed funds. Currently, one of the main disadvantages of investing in unlisted managed funds is that investors do not know exactly the buy or sell price of a fund. Only indicative prices which were based on closing prices of the previous day, are quoted by fund managers at the time of a transaction. By listing a managed fund in the stock exchange, it will remove any doubts and uncertainties on the setting of prices.
    
    11. Current situation of share trading in China ªª
    
    No doubt, China' s securities industry is still in its infancy in terms of the size of capital of securities firms, business scope and management expertise. Since its existence, the industry has been dominated by local commercial banks and a dozen of securities firms. Investment banks are almost non-existent and trust and investment companies only play a modest role.
    
    Banks are banned from any stock market related business such as investing in stocks or lend to firms for doing so, and hence are only involved in the underwriting and trading of government bonds through the interbank RMB market. Securities firms are the major participants in stock related businesses. Most of them have a very low paid-up capital as compared to international stock broking firms and this factor limits their capacity to withst and financial risk and engage in underwriting securities. As a result, their daily activities are restricted to share dealings by private clients and initial public offers (¡°IPOs¡±).
    
    Unlisted managed funds are in an early stage of development in China. The concept of pooling capital together and entrust it with a professional investment manager is not widely understood and accepted. The supervision of the industry is shared by a number of government departments. Improvement in coordinating various departments is required in order to pave the way for future growth.
    
    12.What overseas experience can be adopted for China?
    
    Being typical of a developing stock market, China' s stock market has demonstrated a great volatility and reached unrealistic P/E ratios. It was estimated that before the end of this decade, about 2000 Chinese companies will be listed. Managed funds will give the public a less risky approach to channel their capital to the share market. Such investments will provide a stabilizing force in time of market volatility.
    
    In order to develop a healthy managed fund industry, strong supervision and planning in the following areas should be initiated by the Government:ªª
    
    (a) Securities Law have to be amended so that a single central department is responsible for the following:
    
    - licensing of fund managers.
    
    - rules regarding the offering of unlisted managed funds to the public.
    
    - investigation of frauds and legal power to prosecute offenders.
    
    - monitoring of operations of fund managers and ensuring Consumer Protection Guidelines have been followed (see further explanation below).
    
    (b) Consumer protection law should be passed to protect investors against providing misleading information and fraud. It should also cover the giving of investment advice by client advisors and the disclosure of fees and conflict of interest. In Australia, client advisors have a duty to understand the risk tolerance of their customers and their investment objective and to ensure that investors understand the nature of the recommended investment.
    
    (c) Joint ventures should be formed between international fund managers and security firms (and local fund managers) in China so that the expertise of structuring unlisted managed funds can be transferred to the local market. Initially fund managers should only deal in local shares and not international shares as the latter involve foreign exchange issues.ªª
    
    (d) Priority should be given to educating the general public about the importance of taking a long term view in share investment and the importance of diversification of risk. Investors should be warned that the stock market is not a casino and it is imperative that they seek the help from professionals (such as fund managers and investment advisors) before making an investment decision.

    
    Sources:

    Deaken University, Diploma in Financial Planning course material.
    
    Colonial First State Managed Investment Funds Prospectus 2001/2002.
    
    HSBC China Monthly Report - March 2000.
    
    ASSIRT Market Share Report March Quarter 2002.
    
    Colonial First State - Impact of major events on global share markets from 1980 to 2001.