PLAN DE TRATAMIENTO

Fund investors seek to maximize their fund returns. Thus, minimizing fees and expenditures is one of the keys to achieving superior returns; whereas fund fees enrich FMC and are the major income source of FMC and its managers (Kong and Tang 2008; He 2005). The findings of both Chapter 7 and Chapter 8 of this thesis indicate that the level of fees charged by a FMC significantly reduces FMC performance affirms this argument. Therefore, there is an inherent conflict of interests between FMC and fund investors because of the fee setting, and fees charged by FMC to fund investors are important for investors, FMC, and policy makers. With the characteristics of the corporate model of U.S. mutual fund where each fund is an independent entity, most of extant literature use fees at the fund level as proxy of board effectiveness (Kong and Tang 2008; Ferris and Yan 2007). Given the generally accepted central position the board of directors has in China’s fund industry as discussed in Chapter 5.3 and following existing relevant literature, this study uses FMC total expense ratio (TER) as a measure of board effectiveness in China to investigate how key governance variables impact on board effectiveness in the contractual form of FMC in China (Chapter 7).

23_{Interview notes with a FMC general manager from First State –Cindy Fund Management Company on 7 June 2012.} 24_{Interview notes with an independent director of a joint venture FMC from First State –Cindy Fund Management Company}

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There are different types of fees 25 charged to fund investors, which are somewhat similar in the U.S. and China. In the U.S., there is a strict disclosure requirement relating to fund fees. TER is required by law to be included in the report for investors in the U.S. However, in China there is no relevant regulation to require FMC to report them. Chinese fund investors may or may not be fully aware and understand the effect of those expenses upon fund returns.

Table 16 shows that equity funds occupy the largest proportion of AUM of China’s fund industry, followed by mixed fund. In 2010, overall AUM of equity fund and mixed fund was RMB 2023 billion accounting for 84% of total AUM of the Chinese fund industry. It could be argued that managing equity, mixed and other non-fixed income funds normally requires greater input and more active efforts, perhaps higher skills, and more time by fund managers in their investment strategies than bonds and money market funds.

Mixed funds on average charge the highest TER from 2005 to 2010 followed by equity fund (Table 16). It is worthwhile to note that the year of 2008 witnessed the highest TER for non-fixed income funds such as equity, mixed and other funds although there was a significant drop in AUM except for bond funds. This could be due to the fact that up-front fee charges on the huge inflow of investment into managed funds prior to the global finance crisis, redemption volume however rapidly rose following the crisis and AUM dropped.

Compare the fund TER between U.S. and China, U.S. has seen a declining trend over the past two decades since 1990 (Table 17).TER of equity funds in 2010 was less than half of TER in Chinese equity or mixed fund. As reported by ICI (2011) , the steep decline in fees in U.S. mutual fund can be attributed to the growth of mutual fund sales through employer- sponsored retirement plans. Its loads26 for purchases of fund shares are often waived through such retirement plans. U.S. has more intense competition in the fund industry which could drive down cost and fees. The big gap of TER between Chinese and U.S. fund may signal the presence of greater agency costs and deserves better understanding and investigation.

25_{According to Article 34 of China’s “A management procedure of FMC operation ”in 2004 stipulates that fees could be}

charged to fund investors, including management fees, custodian fees, disclosure fees, fees for hiring accountant and lawyer, fees for holding the meeting for fund investors, trading fees, and other fees regulated in relevant regulation and FMC-investor contact.

26_{The fund investor pays the load to compensate the service of a sales intermediary (broker, financial planner, investment}

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2005 2006 2007 2008 2009 2010 Equity (%) 1.45 1.34 2.26 3.52 2.43 2.45 Mixed (%) 1.91 1.65 2.86 3.94 2.82 2.72 Bond (%) 1.19 2.68 1.6 1.32 2.46 - Money market (%) 0.93 1.95 0.91 0.5 1.74 1.84 Others (%) 1.72 1.37 2.62 4.94 2.29 2.46

Source: Wind database

Table 17: Asset-weighted fund total expense ratio on selected year in the U.S.

1990 1995 2000 2005 2008 2011 Equity funds (%) 0.99 1.06 0.99 0.91 0.83 0.79 Hybrid funds (%) 1.02 0.97 0.89 0.8 0.77 0.8

Bond funds (%) 0.88 0.84 0.76 0.69 0.61 0.62

Note: total expense ratios are measured as asset-weighted averages. Source: Investment Company Institute and Lipper, ICI 2012.

Several factors affect total expense ratio. First, expense ratios often vary inversely with fund assets, simply because of the way of the ratio is calculated. Certain fund costs – such as transfer agency fees, accounting and audit fees, and directors’ fees –are more or less fixed in dollar terms regardless of fund size. In principle, when the value of fund assets rises, these fixed costs become smaller relative to those assets (ICI 2012), thus, a fund’s total expense ratio should be reduced. However, as shown in Figure 12, AUM of 2007 reached the record level of RMB 3039.33 billion, which is more than 4 times the size of AUM in 2006, and TER on average actually rose to 2.26% (2007) from 1.34 (2006), and then even going up to 3.52% in 2008 and stayed high during the years of 2009 to 2010 despite a sharp drop of AUM in 2008 and fluctuations of AUM between 2008 and 2010. It seems that fund expenses have not been pushed down by economies of scale and competition within the fund industry in China, there has been relatively high fees and expenses charged by FMC to fund investors regardless of the changes in AUM. This may suggest that significant agency costs exist in Chinese fund industry. How to protect the interest of fund investors are therefore vital to the healthy development of fund industry.

As listed above, in 2001, CSRC stipulates that the management fee must be charged on a fixed rate over assets under management (AUM), which is paid directly from the fund’s assets and calculated as a percentage of the net assets in the portfolio, as compensation for the contractual investment advice and contractual administrative services provided to the fund by FMC.

Wang (2009) argues that the current “management fee” payment system may motivate FMC to focus on fund AUM rather than fund performance, which may be detrimental to the

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interests of fund investors. Using TER as a proxy for board effectiveness, this study will test what specific internal governance mechanisms enhance board effectiveness.