(Corrects spelling in first bullet point to "Morgan Stanley's")

By Selena Li and Xie Yu

HONG KONG (Reuters) - Morgan Stanley ( MS ) has laid off about 9% of its staff at its asset management business unit in China, two people with direct knowledge of the matter said, as the country's spiralling stock market dampens prospects for its $3.8 trillion fund sector.

Morgan Stanley Investment Management China started reducing headcount in December and the move has impacted about 15 employees, the people said on condition of anonymity as they were not authorised to speak to the media.

This would be the first time Morgan Stanley ( MS ) has cut staff at the China fund unit since it bought out its local partner's 36% stake in the loss-making business for about $54 million in 2023. It rebranded the unit as a wholly owned subsidiary in June.

Morgan Stanley ( MS ) declined to comment.

The downsizing underscores the challenges that global financial firms, including JPMorgan and BlackRock ( BLK ), face in the world's second-biggest economy as a protracted economic malaise batters markets there.

China's blue-chip CSI300 index sank to five-year lows last month, after having lost 11% in 2023, pummelled by an unprecedented debt crisis in the property sector and a lack of large-scale government stimulus.

The weakening of the Chinese market has hit local investors' appetite, resulting in massive redemptions from actively managed equities funds.

The job cuts by Morgan Stanley ( MS ) in the China fund unit adds to the dour outlook for other China-focused jobs in the financial sector including investment banking.

China's onshore fund market saw a muted 6% growth in assets last year after a 1% rise in 2022, slowing down from a staggering annual jump of more than 27% in both 2020 and 2021.

'PLAY DEFENSIVE'

Shenzhen-based Morgan Stanley IM China saw its assets under management decline every quarter after reaching a peak in June 2021, with assets in its funds plunging 53% from the peak to 19.8 billion yuan ($2.75 billion) at end-2023, according to company disclosures.

The unit recorded an operating loss of 48.5 million yuan in 2022 and 23.2 million yuan in the first half of 2023, earnings results of its former joint venture partner Huaxin Securities showed.

The U.S. firm for the first time hired a chief investment officer at Morgan Stanley IM China, Alex Zhou, to steer the investment business. Zhou has previously worked at AIA, where he was head of equity.

The headcount reduction and hiring of Zhou are part of Morgan Stanley IM China's ongoing initiatives to recalibrate the business after taking full ownership last year, a third source with knowledge of the matter said.

One of the first two sources said to "play defensive" amid weaker fundraising prospects was also a key reason for the cuts.

Peter Alexander, founder and managing director of China consultancy Z-Ben Advisors, however, said foreign firms might just be rolling out overhaul or cuts in China units out of "polices of inertia".

"It is more about pressure from the headquarters to reduce expenses anywhere and everywhere," he said.

($1 = 7.1987 Chinese yuan)

(This story has been refiled to correct company name in the first bullet point)