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Week in Review

Funds to Embrace More Elaborate Investments

While one of the big trends in the mutual fund industry has been its embracement of sophisticated alternative investments, mutual funds and hedge funds alike are about to become even more complex in the next year, the Financial Times reports.

In Europe, Asia, Africa and Latin America, funds are taking advantage of the European Union's 2006 Ucits III legislation, which permitted regulated funds to increase their exposure to derivatives and other asset classes.

"This is going to completely change the investment industry as we know it," said Michael Ward, chairman of the Ucits III steering committee at Merrill Lynch. He said that long/short 130/30 funds are only the beginning.

"We are being approached by a number of hedge fund managers asking us if it is technically possible to do convertible arbitrage in a Ucits environment," Ward said. "I'm certain that there is going to be a broader range of strategies to choose from."

Guy Monson, chief investment officer at Sarasin Chiswell, which recently launched a suite of mutual funds that employ hedge fund strategies and attracted $625 million, said, "It's a Big Bang, and we have only just scratched the surface of what we are going to see in the next two or three years. It's hard to underestimate what a revolution this is. You ain't seen nothing yet."

In the U.S., Merrill Lynch estimates that $75 billion is currently invested in mutual funds that use alternative strategies, with two-thirds of that money in 130/30 funds and the rest in market-neutral funds. Steve Deutsch, an analyst with Morningstar, said three of the drivers of the interest in funds that employ alternative strategies are investors' increasing familiarity with hedge funds, lower returns in long-only funds and mutual fund companies' interest in going head-to-head against hedge funds.

China Asset Industry Seen Growing 24% a Year

Assets under management in China have grown an incredible 60% over the past three years, and while growth won't continue at this rate, it will still increase at a clip of 24% a year over the next 10 years.

That's according to a recent report from McKinsey, which says that the investment management industry will be the fastest-growing segment of China's financial services industry, China Daily reports. While the brokerage and mutual fund industry has expanded at a tremendous rate in the past two years, there's room for even more growth, since the Chinese have 79% of their assets socked away in low-yielding bank accounts and only 3% of household assets are currently invested in mutual funds.

Demand will come not only from retail investors but also from the Chinese government, which runs the $40 billion National Social Security Fund and is prompting individual companies to provide pension plans for their workers.

"In 10 years, the assets under management of these enterprise annuities are expected to reach $150 billion, up from today's $15 billion, partly as a result of their increasingly favorable tax treatment," according to the McKinsey report.

Since China expanded the Qualified Domestic Institutional Investor program, which allows the Chinese to invest in foreign investments through domestic firms, from fixed-income to also include equities in May, this will also boost the industry. Evidence of this came already with the offerings of QDII funds by four leading companies, China Asset Management, China Southern Fund Management, Harvest Fund Management and China International Asset Management-each raising $4 billion in a single day.

What could hold the market back, however, McKinsey said, is the lack of diversified offerings. "So far, the vast majority of mutual funds in China have offered strikingly similar compositions [due to] a limited number of attractive companies listed on the Shanghai and Shenzen stock exchanges," the report said. "This makes it difficult for fund managers to differentiate themselves, let alone hedge against the market through other asset classes."

It will also be hard for U.S. and other global asset managers to crack the market since there are already 27 foreign asset managers competing in China. "Multinational financial services companies can't ignore this market, but capturing a large share of it won't be easy," McKinsey said.

Further, China's securities regulator has been very slow and methodical about allowing new funds on the market, for fear of a market crash, and Chinese investors typically cash out of mutual funds within six months, so companies must constantly offer new funds to win investors' loyalty.

China Admonishes Fund Firms to Tamper Growth

The China Securities Regulatory Commission has warned the mutual fund industry to be responsible about its growth, marketing and advertising, and risk controls, and to be sure to hire adequate experts and cut back on short-term trading, which is fueling market speculation.

It is the second notice the CSRC issued for the mutual fund industry, which currently has 341 funds with $444.21 billion in assets under management handled by 59 companies.