China: Subprime for the masses

China: Subprime for the masses

May 1, 2013 11:54am by Simon Rabinovitch and Naomi Rovnick

With Chinese workers enjoying a break from their travails on May 1 for Labour Day, it is an opportune time to look at one gift recently bestowed on them by the country’s financiers. The gift is a new investment opportunity going by the name ‘fund of trusts’, which conjures up a sense of diversification and safety. But a more accurate name might be ‘subprime for the masses’. China’s funds of trusts are inspired by the funds of funds that are common in developed financial markets, allowing people to invest in a blend of other funds – whether mutual funds or hedge funds – to gain broader and more dispersed exposure. In China, the funds are invested in a cocktail of different trust products, which include some of the riskiest, high-yielding investments legally available in the country.

This innovation is notable for one major reason. Until now trust products have typically required minimum investments of Rmb1mn ($162,000) as a way of ensuring that only wealthy individuals put their money at risk. With funds of trusts, the entry barrier has been cut to as little as Rmb100,000 ($16,200). That puts trust investments within the reach of tens of millions of middle-class Chinese.It is easy to understand why Chinese savers would be interested in funds of trusts, which are known colloquially as ‘little trusts’. They offer annual yields as high as 10 per cent, triple the interest rates on ordinary bank accounts. What’s more, the yields are roughly double what investors can get with wealth management products, hitherto the most popular high-yielding alternative to bank deposits.

How can the funds of trusts deliver returns so much higher than wealth management products? It’s simple – their high yield is undiluted. Wealth management products typically consist of a variety of assets, from lower-yielding money-market funds to mid-yielding corporate bonds and high-yielding trust products.

For the funds of trusts, the investment is entirely going into high-yielding trust products. A glimpse into what those trust products are backing was provided in a prospectus recently published online with full details.

The ‘Best Choice No. 1 Product’ is a fund of trusts which gives investors instant access to funds managed by Shandong International Trust Corp, Jiangsu Investment Management Co and Qingdao Guoxin Industry Corp.

Diversification across three different trust companies might seem a good start. The manager of the fund, First-Trust Fund Management, also noted that the investment was guaranteed by the Xiangtan Gaoxin Co, a high-tech firm in Hunan province, and by land in Xiangtan county, just outside the Hunanese capital of Changsha.

But therein lies the rub. Though three different trust companies are receiving funds from investors, they are directing all of the financing at one single recipient. The three are providing loans for the construction of the ‘Tianyi demonstration zone’ in Xiangtan, a sprawling new urban development.

In other words, the much-vaunted diversification of the fund of trusts ends up being an illusion in this case. Investors in the ‘Best Choice No. 1 Product’ are simply lending cash to a property development in Xiangtan that is backed, less than reassuringly, by land in Xiangtan and a large Xiangtan company.

There is at least one saving grace. This fund of trusts, which promises a 9 per cent return, has a high investment threshold of Rmb1mn. Most punters would not be able to afford that.

But according to a series of recent articles in the Chinese press, many other funds of trusts are lowering the drawbridge for ordinary savers. The investment barrier has been progressively cut – first to Rmb300,000, then to Rmb100,000 and even less.

High-yield investment products are a welcome present for hard-toiling Chinese savers. But funds of trusts are one gift horse they may want to look in the mouth