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China’s wealth market: expanding opportunities but unique development path

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This is a sponsored article from Morgan Stanley.

Richard Xu
Head of China Banks and Diversified Financials Research, Morgan Stanley

Household financial assets have been growing in China at a higher pace than GDP in recent years, despite the impact from COVID-19 in the past two years. We believe the wealth management industry represents the best growth opportunity in the China financial services industry and see several key trends emerging in the coming years.

First, we expect household financial assets to more than double over the next 10 years driven by China’s infrastructure-led and industrial-focused economic growth model, along with broad-based income growth, and more diversified needs for wealth management services.

Second, due to the regulatory clean-up that aligned the regulations of all asset management products with global standards, we see the emergence of true wealth management businesses that focus on customer services, investor education and more stable returns, with a transition from a product distribution model to an asset allocation model at leading retail banks and large, payment-focused online wealth management platforms. This should drive further market share consolidation in both the asset management and wealth management business.

Last, we expect notable spill-over benefits from household financial asset growth into the offshore market. We believe a combination of China household financial asset allocation to the overseas market together with China’s overseas household wealth creation (through US and HK IPOs) should grow the offshore assets of China’s high net worth households from US$1 trillion in 2019 to US$4 trillion in 2030.

However, we still expect China to follow a different path to institutionalising household financial assets, as many drivers specific to China will influence the process, such as its different underlying asset mix, tax system, and nature of investor base, which will play an important role in shaping the development of the asset/wealth management industry in China.

We believe China will remain on a different economic development path, generating its own structure of capital demand, which we expect will lead to more fixed income investment opportunities while equity will likely remain a smaller portion of household financial assets than in the US, as the ease of new business formation could entail rising competition for incumbents and more fragmented industries, which may not be favoured by the equity market. In addition, certain industries, particularly those dominated by state-owned enterprises (SOEs), are more focused on building the infrastructure that lays the foundation for business formation than on profit growth and capital appreciation. The combination of these factors has effectively resulted in fewer assets being suitable for the equity market in China relative to its GDP and household income.

The taxation system, with low effective personal tax rates and a lack of capital gain tax, will continue to lead to slower acceptance of defined contribution-type pensions, which largely invest in mutual funds. Asset allocation decisions still largely rest with households, and the middle class and affluent households will still have some preference for stable fixed-income products.

In terms of the source of assets under management (AUM) and client profile perspective, we expect three quarters of industry AUM growth to come from household income and savings with only one quarter from capital appreciation, as the Chinese economic model favours business formation and labour income with government policies that generally support competition and discourage excessive profitability, which are less favourable for capital appreciation. In addition, much wealth rests with first-generation entrepreneurs who require more comprehensive financial services.

We believe the biggest opportunity is in wealth allocation and financial advisory, which were practically non-existent prior to the financial market clean-up. This could allow wealth managers to take share from asset managers, and hence we see more fee income opportunities for wealth managers with less fee rate pressure. In addition, we believe this will be the most important battleground for a firm’s retail financial business, as it will be the most market-oriented and differentiated business within retail financial services.

In view of wealth concentration among first-generation entrepreneurs, who still prefer to make their own investment decisions, as well as a lack of tax incentives to lock in longer investment horizons for the retail investor base, we highlight the following as six key success factors for wealth managers to gain market share in China.

1. The ability to source higher-yielding fixed income products and risk management capabilities in both liquid standardised products and less liquid non-standardised products, such as fixed income and hybrid products, will likely remain the dominant investment options in China.

2. Offering comprehensive financial services, including payments, credit, tax planning, and capital market access, as well as non-financial services, such as providing client access to education, entertainment, social, and healthcare resources.

3. A strong natural client base with proper investor education that enables wealth managers to focus on long-term wealth solutions to help clients expand their investment horizons through cycles rather than drive near-term client activity, especially given a more volatile equity market in China due to its economic development model.

4. Proper KPI and incentive programmes that focus on AUM rather than product sales.

5. Leading tech and AI-empowered tool development to not only improve efficiency but also offer personalised services to investors (newsfeeds, high-touch support during volatile periods, investment ideas), which could prolong investment horizons and enhance returns.

6. However, contrary to some market expectations, we anticipate only a modest shift in household financial assets from deposits to investment products owing to China’s unique capital demand structure, which will provide leading retail banks with a natural competitive advantage. We believe the private banking business will experience further market share consolidation by leading joint stock banks and a few leading city commercial banks in regions with high household financial asset concentrations. We expect major online wealth management platforms to gain share in the mass-market business at the expense of weaker city commercial banks via rising AI robo-financial advisory services.

In light of the dominance of fixed income products in China, we believe having a competitive advantage in equity capabilities and more comprehensive global product offerings will be key winning ingredients for global firms in the overseas market benefiting from the spill-over benefits of China household financial asset growth. We believe Hong Kong, and to a certain extent Singapore, will become the wealth management hubs for spill-over AUM, which will then be allocated globally. Hence, we believe equity-focused wealth managers in Hong Kong and Singapore could benefit the most from a quadrupling of Chinese household assets in the offshore market.

This is a sponsored article from Morgan Stanley.

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