An increasing number of Chinese investors are buying into the concept of diversified fund asset allocation, spurring demand for funds of funds (FOFs). The interest could persist over the next few years, thanks to prospects in third-pillar pensions and the shift towards buyer-side investment advisory.

According to Eastmoney statistics, FOF assets under management (AUM) more than doubled to RMB194.3 billion (US$30.5 billion) over 2021, recording a three year-CAGR of 128.0%. This was driven by exponential growth in balanced FOFs, which occupied the biggest marketshare of FOF AUM, rising from 72.2% in 2017 to 96.2% in 2021, suggesting that investors are seeking diversification across various assets.

A few factors have contributed to FOFs’ growth, some of which could continue to spur their expansion. In terms of product features, FOFs provide a higher degree of diversification and low maximum drawdowns amid heightened market volatilities. Flagship FOFs with star manager teams from leading FOF managers have also earned investors profits over the past two years and built product recognition.

The distribution focus on assets under administration (AUA) has also boosted FOF prospects. In March 2021, the industry’s self-regulatory body, the Asset Management Association of China, disclosed distributor rankings by non-money market AUA as well as equity and balanced fund AUA for the first time. Such disclosures underscore the regulators’ intention to encourage longer-term holdings of fund investments, measured by AUA rather than gross sales volumes, which can be highly associated with fund churning. In addition, the introduction of the pilot fund investment advisory scheme in China has enhanced investors’ awareness of proper asset allocation, which many balanced FOFs can achieve.

As many FOFs show their merits with longer investment horizons, distributors could pay more attention to these products to grow their AUA. For example, they could focus on pension target-date funds (TDFs), as many of them are associated with mid-to-long-term regular investment or saving plans. Moreover, some banks’ wealth management subsidiaries have been subscribing to FOFs as underlying assets for their banks’ wealth management products.

Managers have developed ordinary FOFs as well as pension target funds—FOFs adopting either TDF or target-risk fund strategies for the purpose of retail retirement—to build track records in preparation for an upcoming top-level system design for the nation’s third-pillar pensions. Adding to the variety of FOFs, several asset managers rolled out China’s first batch of FOF-listed open-end funds last October. These funds, which trade on local stock exchanges, provide alternatives for investors who want to redeem earlier from existing closed-ended FOF products.

“There is great growth potential for China’s FOF sector in terms of assets and product variety, thanks to investors’ demand, solid long-term returns, and managers’ focus,” said Ken Yap, managing director, Asia. “Managers are likely to continue their efforts at innovation and roll out more FOF products amid current market uncertainties.”