Major risks
Recognised Mainland Funds are subject to the risks which are applicable to investment funds in general. In addition, Recognised Mainland Funds are also subject to the following key risks associated with the MRF arrangement:
Quota restrictions
The MRF scheme is subject to an overall quota restriction. Subscription of units in a Recognised Mainland Fund may be suspended at any time if such quota is used up.
Failure to meet the eligibility requirements on an ongoing basis
If a Recognised Mainland Fund ceases to meet any of the eligibility requirements under the MRF, it may not be allowed to accept new subscriptions. In the worst scenario, the SFC may even withdraw its authorisation for the Recognised Mainland Fund to be publicly offered in Hong Kong for breach of eligibility requirements. There is no assurance that the Recognised Mainland Fund can satisfy these requirements on a continuous basis.
Different market practices between Mainland and Hong Kong
Market practices in the Mainland and Hong Kong may be different. For example, Hong Kong investors may hold units in the Recognised Mainland Fund through the Hong Kong representative or a distributor (as the case may be) as nominee on behalf of the investors. The nominee shall exercise voting rights of unitholders according to the instructions of underlying investors. Hong Kong investors should understand the difference in position from Mainland investors where Mainland investors are directly registered as unitholders and as such able to directly exercise voting rights as unitholders.
Recognised Mainland Funds may be classified and named differently from other SFC-authorised funds in Hong Kong. For example, there is a type of fund called “enhanced index fund” in the Mainland which is different from a typical SFC-authorized index tracking fund (passively managed) in Hong Kong. “Enhanced index fund” aims to outperform its designated benchmark. It invests part of its assets in securities that closely match the performance of an index. The remaining assets of the fund will be actively managed by the fund manager. Therefore in Hong Kong, “enhanced index funds” are regarded as actively managed/general equity funds (instead of passively managed index funds). Investors should check from the offering documents of Recognised Mainland Funds to understand their nature and investment strategy but not just rely on the name and classification.
In addition, operational arrangements of Recognised Mainland Funds and other public funds offered in Hong Kong may be different in certain ways. For example, subscriptions or redemption of units of a Recognised Mainland fund may only be processed on a day when both Mainland and Hong Kong markets are open, or it may have different cut-off times or dealing day arrangements versus other SFC-authorised funds. Investors should ensure that they understand these differences and their implications.
Investment risk
Recognised Mainland Funds involve investment risk. There is no guarantee of the repayment of principal or payment of dividend or distribution. Further, there is no guarantee that the investment objectives can be achieved and that the stated strategies can be successfully implemented.
Risks relating to Mainland tax liability
Currently, certain tax concessions and exemptions are available to Recognised Mainland Funds and/or their investors under the MRF regime1. However, there is no assurance that such concessions and exemptions or the relevant Mainland tax laws and regulations will not change. Any such changes may adversely affect the Recognised Mainland Funds and/or their investors who may then suffer substantial losses.
Concentration risk/Mainland market risk
A Recognised Mainland Fund invests primarily in securities related to the Mainland market and may be subject to additional concentration risk. Investing in the Mainland market may give rise to different risks including political, policy, tax, economic, foreign exchange, legal, regulatory and liquidity risks.
Currency risk
Renminbi is still not yet freely convertible and is subject to exchange controls and restrictions. As Recognised Mainland Funds are denominated in renminbi, non-renminbi based investors are exposed to fluctuations in the renminbi exchange rate against their base currencies. Like any currency, the exchange rate of renminbi may rise or fall.
Risks relating to the Mainland equity market
- Market risk
The Recognised Mainland Fund’s investment in equity securities is subject to general market risks, whose value may fluctuate due to various factors, such as changes in investment sentiment, political and economic conditions and issuer-specific factors.
- Volatility risk
High market volatility and potential settlement difficulties in the Mainland equity market may also result in significant fluctuations in the prices of the securities traded on such markets and thereby may adversely affect the value of the Recognised Mainland Fund.
- Liquidity risk
Securities markets in mainland China may be less liquid than other developed markets. A Recognised Mainland Fund may suffer substantial loss if it is not able to dispose of investments at a time it desires.
- Policy risk
Securities exchanges in Mainland typically have the right to suspend or limit trading in any security traded on the relevant exchange. The government or the regulators may also implement policies that may affect the financial markets. All these may have a negative impact on the Recognised Mainland Fund.
- Risk associated with small-capitalisation/mid-capitalisation companies
The stock of small-capitalisation/mid-capitalisation companies may have lower liquidity and their prices are more volatile to adverse economic developments than those of larger capitalisation companies in general.
- High valuation risk
The stocks listed on the Mainland stock exchanges may have a higher price-earnings ratio (in particular the Shenzhen stock market). Such high valuation may not be sustainable.
Average P/E ratio of the Mainland and Hong Kong stock markets:
As at 28 July 2015 | Shanghai | Shenzhen | Hong Kong |
---|---|---|---|
Average P/E ratio (times) | 18 | 47.4 | 10.8 |
To understand more about the risks relating to the Mainland A share market, please also refer to the Mainland market risk.
Risks relating to the Mainland bond market
- Interest rate risk
The value of bonds or debt investments is expected to be inversely correlated with changes in interest rate (ie bond prices will generally go down when interest rates go up). Any increase in interest rates or changes in macro-economic policies on the Mainland (including monetary policy and fiscal policy) may adversely impact the value of the Recognised Mainland Fund's bonds or debt instruments portfolio.
- Credit risk
Investment in bonds or debt instruments is subject to the credit risk of the issuers which may not be able to make timely payments of principal and/or interest. In the event of a default or credit rating downgrading of the issuers of the bonds or debt instruments held by the Recognised Mainland Fund, valuation of the Recognised Mainland Fund's portfolio may become more difficult and investors may suffer a substantial loss as a result.
- Risks of investing in unrated or lower rated bonds
Some of the bonds or debt instruments held by the Recognised Mainland Funds may be rated lower or may not be rated by any rating agency. Such bonds or debt instruments are generally subject to a higher degree of credit risk and a lower degree of liquidity, which may result in greater fluctuations in their values and consequently, the net asset value (NAV) of the Recognised Mainland Fund.
- Risks associated with local Mainland credit rating agency
The credit appraisal system in the Mainland and the rating methodologies employed in the Mainland may be different from those employed in other markets. Credit ratings given by Mainland rating agencies may therefore not be directly comparable with those given by other international rating agencies.
- Downgrading risk
Downgrading of bonds or debt investments by the credit rating agencies may adversely affect the price and liquidity of the securities. If the Recognised Mainland Funds continue to hold such securities, they will be subject to additional risk of loss and the Recognised Mainland Funds may not be able to sell the securities that are being downgraded.
- Volatility and liquidity risk
Mainland's bond market is still in a stage of development and the market volatility may be higher as compared with other developed markets. Besides, the bid and offer spread of renminbi bonds, whether traded in the inter-bank market or listed bond market, may be high and the Recognised Mainland Funds may therefore incur significant trading costs and may even suffer losses when selling such investments.
In the absence of a regular and active secondary market, the Recognised Mainland Funds may not be able to sell their bond or debt instrument holdings at prices the fund manager considers advantageous and may need to hold the bonds until their maturity date.
If sizeable redemption requests are received, the Recognised Mainland Fund may need to liquidate its listed bonds or debt instruments at a discount in order to satisfy such requests and the Recognised Mainland Fund may suffer losses as a result.
1For details, please refer to the Mainland tax arrangements for MRF released by The Ministry of Finance, the State of Administration of Taxation and the CSRC(simplified Chinese only). If in doubt, investors should seek their own tax advice on their Mainland tax position with regard to their investment in Recognised Mainland Funds.