The Growth in China’s Money Market Funds Could Pose Risks

some of the money
In February, the most prestigious international financial institution in the world, the International Monetary Fund, rated China as the number one economic superpower in the world, surpassing the United States based on the purchasing power parity of gross domestic product indicator. In other words, China produced 17% of the world’s GDP in 2014, while the U.S. only produced 16%, making it the stronger economic power in the eyes of the IMF.

Now, this dominating economic superpower’s asset management industry is massive. Two years ago, online money market funds arrived in China, prompting explosive growth, as well as a transformation in the way millions of Chinese invest their savings.

However, the booming popularity of money funds has led several investment experts to grow concerned about the consequential risks developing in the industry.

According to Investopedia, a money market fund is an investment whose objective is to earn interest for shareholders, while maintaining a net asset value of one dollar per share. A money market fund’s portfolio is comprised of short-term securities — meaning they last for less than a year — representing high-quality, liquid debt and monetary instruments. In the United States, money market funds hold more than $3 trillion, making them critical to investors, corporations, municipalities, and the overall economy.

The appeal of money market funds is strong, considering the fact that most offer annual returns of 4 – 6%, compared to the 3% Chinese individuals receive on their bank deposits. The returns have helped money market funds’ assets under management grow almost 15-fold in the past four years to 1.8 trillion yuan, or $306 billion at the end of 2014.

Although the funds offer high interest rates, Robert Pozen, former chairman of the oldest U.S. mutual fund company, MFS Investment Management, told CNBC that “they are not explaining that in many cases this type of paper is not top quality. This is essentially what we would call primary junk funds in the U.S. — paper that’s usually below investment grade, fluctuates daily in terms of interest rates and from time to time defaults.

“The big risk is selling to relatively unsophisticated investors over the internet who probably do not know what they are getting into. There is a real possibility of loss here.”

Rating agency Fitch has noted that the amount of retail investor cash flowing into the funds is a reason for concern. When markets become stressed, the behavior patterns of retail investors tend to lead to periods of mass fund exodus.
Ultimately, it means trouble for Chinese investors, who may not know what they’re getting into.

“Do investors in China know what kind of fund they are getting into?” asked Pozen. “I bet a lot of people do not understand those risks.”

He also added that the funds should be properly labeled, and the value of their underlying holdings needs to be “disclosed properly.”

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