The Technical Challenges for QDII funds in 2012

Written by Helen Lin || April 24 2012

Since the first QDII quota of US$500 million was allocated to the HuaAn fund in 2006, the quota allocated to security companies and fund companies has maintained steady growth. As of the end of February 2012, US$44.4 billion of investment quota was allocated to fund companies and security companies, compared to US$44.4 billion and US$40.6 billion for 2011 and 2010.

However, contrary to the stable increase of the QDII quota, the performance of QDII funds as a whole was barely satisfactory in these years. All the QDII funds in 2008 suffered great losses due to the global turmoil. Although the performance slightly showed signs of recovery in 2010 after a one-year suspension of QDII program, almost all the QDII funds were trapped again in a bad situation in 2011. Only 2 out of all 48 QDII funds realized positive returns in 2011. High volatility and global uncertainty created by European sovereign debt crisis carries some of the blame for the poor performance, but domestic fund managers are still facing other challenges.

Foreign exchange rate risk

The foreign exchange rate risk is an inevitable challenge to all the QDII program participants. Normally, compared to investing in a single oversea market, investing in multi-markets, as some participants have already done, would further spread the exchange rate risks. However, it did not work under the situation in 2011 because renminbi appreciated simultaneously against several other major currencies. For example, renminbi has risen 5.1%, 7.9% and 5.2% against US dollar, Euro and British pound respectively on an annual basis. In this case, both the bad performance of the global capital markets and the appreciation of renminbi brought great losses to all the oversea investors.

In fact, the renminbi has kept appreciating unilaterally against the US dollar in recent years, which is a big concern for those investors investing in the U.S. capital markets. But the good news is that, this year, the central bank plans to further improve the renminbi exchange rate formation mechanism and enhance two-way floating renminbi exchange rate flexibility, which will change the former appreciation unilateral situation and mitigate the foreign exchange rate risk in overseas investment.

Domestic trading systems

In the past few years, QDII funds have experienced large transitions and innovations, with changing from first investing in only Chinese companies listed on HKEx to broadening coverage of stocks, bonds, futures, ETF and FOF in both developed and emerging world-wide capital markets. QDII fund managers’ oversea investing experience, how to enter different countries’ capital markets, and how to establish advanced backend systems suitable for different markets and different portfolios are big concerns and challenges for the funds.

Although fund managers currently exhibit a strong preference for a passive approach like ETFs and FOFs, more active global strategies will be considered in the future, and the demand of sophisticated trading systems will increase to support those active strategies.

The current functionality of most domestic trading systems is limited and most cannot be enhanced to handle the additional demands of sophisticated portfolio management in a complex overseas investment environment. More advanced backend systems are needed to minimize the time latency of transmitting oversea market data, optimize the investment portfolio, carry out the valuation and settlement of international assets, and balance the assets under multi-currency and multi-accounting rules.