What is driving the surge in interest in private equity in China?
The Chinese government as a whole is trying to foster the private equity industry in the country. The capital structure in China is extreme – on the one hand we have the public equity market which has extreme fluctuations, so much so that it can even have an adverse social impact; on the other hand, we have banks funding businesses, where ultimately, the state is taking most of the risk. Anything between the two that directly links the investor with the enterprises’ great capital needs is encouraged greatly. As a consequence, the government is fostering the private equity industry as a whole and is trying to build globally – or, at least initially, nationally – competitive GPs.
Private equity is being viewed as a professionally managed investment which bridges business and capital. Despite the perception of abundant liquidity, there is still a need for high levels of capital in China. The surge in interest is partly also because private equity has had a positive impact on companies in China. Most companies have had a positive experience with private equity in terms of an improvement in internal management, corporate governance and development startegy and the like.
How was CITIC Private Equity Funds Management conceptualized?
CITIC Private Equity Funds Management was set up in the macro context I just spoke about. We obviously want to leverage our strong institutional backing as well as the state council’s and the government agencies’ support. But we want to make sure we set up a private equity fund that complies with global standards. That is the overall backdrop. Specifically, our GP has shareholding from institutions but our investment decisions are independently made at the managers’ level. All of our investment committee members are essentially from the fund manager itself. We may be institutionally backed, and that is to our advantage, but we set ourselves global standards and benchmark ourselves against the best of the breed, the likes of Blackstone or KKR.
Your maiden fund is the largest RMB-denominated fund ever raised. What is it you think Chinese LPs are looking for and what would you attribute your success to?
We have a three-fold value proposition. First and foremost, we have a strong professional team with experience and a strong track record. Our chairman is the ex-chief investment officer of China Life Insurance. Similarly, other members of the team have a strong track record in managing large portfolios of capital. Secondly, people like the set up of the fund where it has strong institutional and government backing and is managed professionally and independently. Thirdly, increasingly people see the need for a mix of local expertise with global exposure. We have combined local experience with people who have global exposure – they have worked at the likes of P&G, GE or McKinsey for years. In that aspect, there is a unique blend of local expertise with global exposure. These are the three things that local LPs saw and that partly contributed to our success.
People in China now believe that the local breed of managers supplemented by international vision can bring competitive advantage to the table.
Who are some of the key investors in the CITIC Mianyang Private Equity Fund?
We have four categories of LPs. The first is the major Chinese financial institutions – this includes the National Social Security Fund and other large banks. The second category is the investment arms of state owned enterprises (SOEs). The third category of investors comprises companies listed on the stock markets. And finally, the fourth category consists of private enterprises. Here are some important numbers: we have a total of 38 LPs and a majority of them fall into the two latter categories – what we call non state-owned money. And equally importantly, more than 50 percent of the money we have raised has come from the private sector – again highlighting that we don’t have commitments only from the state and affiliated bodies.
There has been a wave of domestic funds announced over the last year. Is there sufficient interest on the part of domestic LPs and do you the see the growth of RMB funds continuing?
Having approval for a fund is not equal to fundraising success. Fundraising in China is actually not easy as there are very few mature LPs. The institutions here would like to make strategic investments and have direct stakes in companies on their own. Private entrepreneurs, on the other hand, are used to investing in the stock markets. As a result of the boom in the last couple of years, it was viewed as an easy way of making money. Having managers take care of money is not a familiar concept in China.
Besides, local LPs are very picky. You need the characteristics I have described in order to be successful. There will be many, many RMB funds that will be announced, but there will be only a handful in the category I’ve described. I believe such large funds will be the exception rather than the rule. Hopefully, we’re one of those funds. But like in any industry in any country, some winners will emerge and that will be dictated by the investment track records.
Are regulations permitting Chinese LPs to invest in private equity moving in sync with the number of funds being registered, or is the process still too slow?
The larger institutions such as the National Social Security Fund have a lot of capital and a large allocation to private equity. The question essentially is ‘Can I trust this GP to manage my money’? I think it will all come down to the maturity of the teams and their track records. As the industry becomes more mature, I don’t think the amount of capital available will be a major bottleneck, though [LPs will be] very selective. Currently the total commitment to private equity in China is probably less than it is just in the state of California, and the growth potential is substantial.
For example, insurance companies are not allowed to invest as LPs, but there is an ongoing discussion on how that category can be opened. That is an example of a regulatory change that can potentially increase the number of sizable LPs as well as the allocation of capital to private equity in China. I want to be clear that it is not regulations that pose a bottleneck for private equity but whether people want to open their wallets.
Many Chinese institutions seem to favour making direct investments. Do you think we will see the development of an LP community along traditional lines in China?
Well you have a lot of Western LPs increasingly looking to make direct investments or co-investments. China is coming from the opposite direction. I think we will see a convergence. As of now in China, domestic LPs believe there is no one to trust and they trust themselves the most. As the private equity industry here establishes a track record and as the domestic institutions realise that the stock market is not an automatic cash machine, there will be more positive openness to private equity. The NSSF already has a distinct allocation to private equity. China Investment Corporation is doing the same on the international front. In time, I think we will see Chinese LPs and Western LPs converge.
Does your maiden fund employ the traditional fund terms and structure, or are certain terms different to suit the Chinese market?
Our terms are pretty much squarely in the middle of international norms. One of the biggest things we emphasise is that we are an international-standard private equity fund and, as such, we have the same structure as other global private equity funds elsewhere in the world. We are not a captive fund – we are backed by institutions but the independent decision-making mechanism and the incentive structure that we have in place with respect to a split of management fees and carry between the parent and the managers is favourable and more than sufficient for the latter. While we are supported by institutions, we are international market-oriented and none of our terms would be surprising to anyone in the global private equity market.
As the domestic private equity industry grows, how do you see the role of the foreign players evolving?
I think we will continue to have a large market for foreign players. The private equity market has been growing, and traditionally, foreign players have had a larger market share. Now local GPs are entering into the market. We strive to be the market leader in China and we are confident that we will be.
The advantage foreign firms have is that they have global expertise, but the challenge for them is to understand the nuances of this specific market. How can you build a local team and how you can be perceived as friends by your current and potential portfolio companies?
What in your opinion is the biggest potential obstacle to the development of the private equity industry in China?
Hopefully as an industry, we don’t make too many bad investments. The private equity market is fragile and not everyone in the country understands it. We need to create value for shareholders of the portfolio companies, and we need to help management. We need to get positive feedback which will give more confidence to regulators and investors. If we get into vicious competition and we go and make grossly-overpriced investments, then we will destroy value for shareholders and people will question what we are doing. Hopefully, international and domestic investors can work together. Investing is a track-record based industry and if we can do good things, then the industry will grow. The reputation of the private equity industry is one of the most important things we need to care about.
Wu Yibing is the president of CITIC Private Equity Funds Management, the private equity platform of state-backed CITIC Securities, which closed its debut private equity fund on RMB9 billion ($1.3 billion) in January, making it the largest fund ever raised in Chinese local currency.
The firm, which has more than 60 investment professionals, has already made 12 investments worth RMB2.5 billion. It invests across sectors including financial services, energy and resources, consumer goods and manufacturing.