China's social security fund formally entered the stock markets last month after prolonged bickering among fund owners, academics and market professionals.

The fund's capital has been used for the launch of follow-on and rights issues of four listed companies on the domestic A-share markets.

Before the fund's entry, many had expressed doubts about how it would perform. The market's protracted bearishness, its history of instability, the immaturity of domestic fund managers and the unsatisfactory quality of listed companies were all behind the sceptical sentiments.

For the social security fund, of paramount concern was a balance between risks and returns. With predictable long-term liabilities, pension funds are not normally invested in high-risk equities.

The social security fund used to have nearly all its funds in banks and the bond market, with little investment on the stock market. The income could scarcely meet the growing demand for welfare funding.

Fund owners said they believe the stock market can garner satisfactory returns for pensioners in the long run.

The government lifted the stock-investment ban on the National Council for the Social Security Fund in 2001 as a last resort to cover the increasing number of urban people who were retiring. The government set a 40 per cent asset-allocation cap on the amount that the fund could invest in stocks and a 10 per cent cap for bonds.

The council is the administrator of the pension fund, which was worth 124 billion yuan (US$15 billion) at the end of last year. The body has authorized six Chinese fund managers to use its capital to buy mutual funds and to trade in stocks.

The fund managers are the Southern, Boshi, Penghua, Changsheng and Harvest fund-management companies and the China Asset Management Co, and they are based either in Beijing or Shenzhen. Each was given an investment quota of between 2 billion and 3 billion yuan (US$240 million to US$365 million), according to industry sources.
It is estimated that about 4 billion yuan (US$480 million) will enter the market in the first three months of operation.

The initial market reaction showed that the pessimism of some analysts may not have been groundless.

The shares bought with the pension fund through the six fund managers have performed poorly. At best, the shares have floated narrowly around the issue price.
The fund managers have been criticized for resorting to a short-term investment strategy.

This is also reminiscent of a fiasco in the market two years ago involving the social security fund.

Its specially authorized 300-million-share placement in the oil giant Sinopec in 2001 resulted in huge losses being reported in the fund council's 2002 annual report.

Although the price of Sinopec shares has risen in recent months, it remains below the issue price, which means the fund has been registering paper losses through its holding of the shares.

Worse, the pension fund has been put in an even more awkward position by the successful debut of the first qualified foreign institutional investor (QFII) scheme on the mainland bourses.

The banking group UBS, the first foreign institutional investor in China's US$500 billion yuan-dominated A-share market, ordered shares in the telecom equipment maker ZTE Corp, Baoshan Iron and Steel, Shanghai Port Container and Sinotrans Air on Wednesday last week.

The four had a roaring start the next day, with the lowest rise being 3.97 per cent, stoking a positive sentiment to jazz up the whole market.

"This is evident of the immature psychology of domestic investors," said an analyst from Galaxy Securities, who asked not to be named.  "The market had much better expectations for the entry of the first QFII."

As both the pension fund investment and the QFII set-up are aimed at long-term returns, however, immediate loss or gain does not mean much. Time is needed to tell who will have the last laugh.

A Shanghai-based fund manager who refused to be named said:  "The worry about and cold reaction to the pension fund's entry into the market are understandable. But, since it has been in the market for only a short period of time, it is too early to judge whether the investments have been successful or not."

Currently, it is not important whether the fund is temporarily gaining or losing money on the market, he said. What matters is how it invests, he added.

Analysts said the buying of shares by the fund is prudent. Managers have targetted shares in steadily growing industries, such as energy, paper and building materials.

Although the follow-on issue shares that the fund has bought are not faring well at this time, they belong to the category of steadily rising shares, according to analyst Ruan Fei from Oriental Securities.

The situation thus conforms to the long-term investment requirements of a pension fund, which cannot afford to lose in the long run because its very nature means that old-age pensioners will suffer.

"As a new market, China's stock market has its systematic risks. But this does not mean the pension fund cannot enter the market," said the Shanghai-based analyst.  "Fund managers need to choose proper strategies, based on the reality of the market, to circumvent possible risks that threaten the fund's security.

"It will depend on the managers' investment ability."

The expertise of China's fund managers has improved a lot in recent years, and overall returns exceed those of bank deposits, according to the analyst.

Yi Xianrong, an economist from the Institute of Finance and Trade Economics under the Chinese Academy of Social Sciences, agreed.

Although he fiercely opposes the pension fund's entry into the market at the current time, Yi admitted that the fund managers chosen by the National Council for the Social Security Fund are competent.

"There are few problems with the managers in the shares' poor performance this time."

But he warned that some problems must be solved effectively for the pension fund's long-term benefit.

The property rights structure of China's investment funds needs to be improved. Currently, 84 per cent of industrial capital is State-owned, according to the Chinese Academy of Social Sciences' Centre of Financial Research.

"The over-concentration of the funds' property rights will affect the industry's long-term dynamics," said Yi.

The quality of listed companies should also be improved to provide a better investment arena for the pension fund in the future, Yi added.