(Bloomberg Businessweek) -- It’s hard to tell whether the three-story building in a residential area of Shanghai is a stock brokerage or a senior center. On the first floor, white-haired men and women, some stooped with age, are gathered alongside rows of outdated computers set in wooden boxes. Upstairs, more people sit in VIP rooms, some reading newspapers, others playing poker, and a few peeling and eating shrimp.
They’re stock traders, spending a normal Thursday morning at the Quyang Road branch of Zhongtai Securities Co. Individual investors make up 80 percent of the trading volume in China’s $7.6 trillion stock market. And they’ll be among those on the other side of the trade as global fund managers march into China’s equity market after MSCI Inc.’s decision to include some Chinese mainland-listed A shares in its emerging-markets index beginning next year.
China’s stock market has been driven by retail investors from the beginning. Although the Shanghai and Shenzhen exchanges were set up in 1990 and 1991, respectively, the first mutual funds didn’t open for a decade. Regulators have sought to professionalize the stock market by promoting the wealth management industry, but recurrent scandals—such as cases of fund managers profiting by trading ahead of their clients—have prompted the majority of investors to keep picking stocks themselves. It’s one reason China’s markets are so volatile. “Chinese retail investors don’t have strong fundamental research and have a herd mentality, and stocks can be in fashion and out of fashion very quickly,” says Victoria Mio, chief China investment officer for the Hong Kong unit of Robeco Groep NV.
Despite the rise of PC- and smartphone-based trading around the world, many investors in China still prefer to trade at brokerage houses, even at higher commissions. The habit has exacerbated a turf war among firms to expand physical offices. There are 17 brokerage locations in Tibet alone, and more than 10,000 in all of China, according to a tally by the Securities Association of China.
More than 70 percent of the 20,000 clients at Zhongtai’s Quyang Road location are older than 60, says Miao Zhuli, head of the branch. “They see this as a home away from home,” she says. “Sometimes they just come to hang out instead of trading.” Miao has been in the brokerage business for 17 years, starting when orders from retail investors were submitted on slips of paper. Brokerages introduced trading terminals not long after, and the retail traders never left.
The U.S. stock market had a similar phase. The proportion of U.S. public equities managed by institutions was just about 7 percent or 8 percent by market value in 1950 but has risen steadily over the last six decades, to about 67 percent in 2010.
Qiu Jiewen, 55, takes a 40-minute bus ride from her home to the Zhongtai branch every weekday to trade stocks on the second floor. The biggest draw for her is the human touch, she says. Plus the free tea and snacks. “I like the atmosphere here,” says Qiu, who has about 3 million yuan ($438,470) in her stocks account. “They have good service. You make some money and have a good time.” Qiu is paying a commission of 0.3 percent, about 10 times what she would pay if she did her trading online. She picks her stocks based on tips from friends and consultants at the brokerage and doesn’t bother herself with numbers such as price-earnings ratio or earnings per share.
This is a mixed blessing for global fund managers. The inclusion of Chinese A shares in a widely followed index means they’ll find their way into more index funds, though for now they’ll have only a small allocation. Active managers whose performance is benchmarked against the index will also have to pay more attention to Chinese shares.
Some managers think this is a market where they might have an edge. “It’s hard to beat the benchmark in developed markets,” says Gao Ting, head of China strategy at UBS Securities Co. in Shanghai. In markets such as the U.S. and Europe where institutional investors dominate, professionals have struggled to deliver better returns than those of index funds, because any new information about a stock tends to be quickly reflected in its price. China, on the other hand, stands as “fertile ground for alpha generation,” says Robeco’s Mio, using industry jargon for market-beating performance. Put more bluntly, the pros may be able to take advantage of the amateurs’ mistakes.
But that’s hypothetical. Another important player in China’s market is the state, a major shareholder in many companies. And to profit in the stock market, it’s not enough to be right; the market also needs to eventually agree with you. In the meantime, China’s markets can produce head-spinning volatility—they had big crashes in 2015 and early 2016—and widely divergent performances. For example, medical stocks have returned almost three times more than the benchmark CSI 300 Index since 2010, according to Gao. That’s good news for a manager on the right side of that trade, but an investor who stayed away from medical stocks could have underperformed badly.
“China’s stock market has a lot of unique opportunities, but foreign managers need to fully understand it, all its quirks and tricks, to be successful,” says Allen Kuo, director of open market investments at Gopher Asset Management, which managed 120.9 billion yuan at the end of last year. The latest example of one of those quirks: Shares of Shenzhen-listed Wisesoft Co. surged 6.4 percent, with trading volume six times the three-month average, on the day after the 2016 U.S. presidential election, perhaps because its local-language name, “Chuan Da Zhi Sheng,” sounds like “Trump Wins Big.”
To contact Bloomberg News staff for this story: Gary Gao in Shanghai at cgao58@bloomberg.net.
To contact the editors responsible for this story: Rob Urban at robprag@bloomberg.net, Sam Mamudi Pat Regnier
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