What it means
China restricts how quickly money can leave the country. These capital controls help the authorities manage the currency and the financial system.
The QDII scheme is a controlled doorway that lets certain qualified institutions send money abroad for investment. To take part, an institution applies for approval and receives a quota, which is a limit on the amount of overseas investment it may make.
The quota is allocated by the foreign exchange regulator. Once approved, the institution can buy overseas shares, bonds and other assets on behalf of itself or its clients.
For ordinary investors in China, QDII funds are one of the main ways of getting access to foreign markets. An investor buys units in a QDII fund in the local currency, and the manager invests the money in overseas assets.
This lets people diversify away from the domestic market without moving money themselves, and it spares them the paperwork of opening a foreign brokerage account. QDII is the mirror image of QFII, the Qualified Foreign Institutional Investor scheme, which lets approved foreign institutions invest in China's markets.
Together they form the main channels for cross-border investment in each direction. Over time, other routes have also developed, so the role of each scheme has changed.
QDII funds carry the usual risks of overseas investing. These include market risk, currency risk because the assets are priced in foreign currencies, and the risk that quotas run out.
When the quota is used up, funds may stop accepting new money, and their units can then trade at a premium to the value of the underlying assets. A nuance for global businesses is that QDII matters when dealing with Chinese asset managers and institutions.
Their ability to invest abroad is limited by quotas and rules, which can affect when and how much capital flows into overseas deals. Anyone planning to raise money from such investors should ask whether they hold quota.
In practice
Real-world examples.
Example
A Chinese asset manager is granted a QDII quota and launches a fund that invests in US technology shares. Investors in China buy units in the local currency. The fund converts the money into dollars and buys the shares.
Example
A Chinese insurance company wants to diversify its portfolio by holding some global bonds. It uses its QDII approval to invest within its quota. The insurer reports the holdings alongside its domestic assets and tracks the exchange rate carefully, since a fall in the foreign currency against the local one would reduce the value of the bonds when measured at home.
Example
A fund of funds in Europe seeks Chinese institutional investors. Its team asks prospective investors whether they have unused QDII quota. One investor has plenty, while another has used it up and cannot commit more.
Case study
Seen in the real world.
Jadewave Asset Management is an illustrative, fictional Chinese fund company that launched an overseas shares fund under its QDII quota. Demand was strong, and within weeks the fund had taken in the whole amount of its quota, equal to about $300,000,000.
At that point the manager had to stop accepting new subscriptions. Because investors still wanted units, the price on the secondary market rose to several percent above the value of the fund's underlying assets. Some investors who bought at the premium later lost money when the premium disappeared.
The illustrative lesson was that quota limits can distort prices, and that a fund's market price and its underlying value are two different things. Jadewave then applied for additional quota, published the size of the premium each day, and explained the premium risk clearly to investors in plain language. Its compliance team also added a warning to the fund's marketing material so that nobody bought units at a high premium without understanding what they were paying for.
Watch out
Common mistakes.
- Assuming any Chinese institution can invest abroad freely, when approval and a quota are required under the QDII rules.
- Confusing QDII with QFII, when QDII covers money going out of China and QFII covers foreign money coming in.
- Ignoring currency risk in a QDII fund, since the underlying assets are priced in foreign currencies.
Questions
People also ask.
What does QDII stand for?
It stands for Qualified Domestic Institutional Investor, a Chinese scheme for approved domestic institutions to invest overseas.
Why do QDII funds sometimes trade at a premium?
When a fund has used up its quota and cannot take new money, demand can push the market price above the value of the assets.
Can individuals use QDII?
Individuals typically access it by buying units in a QDII fund rather than holding a quota themselves, because the quota is granted to the approved institution and not to the investor.
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