China’s PE funds may not be quite what they seem to be

By Paul Mackintosh - 20/02/12

With the Obama administration now also turning its fire on carried interest, time to shift attention elsewhere: to China. For while US GPs (general partners) face the prospect of fresh curbs on their industry, the PRC is busy hatching fund vehicles the likes of which Asia has never seen.

One SOE (state-owned enterprise), bank and even ministry after another is rolling out jumbo RMB private equity funds. The China Railway Private Equity Fund tips the scales at an RMB100 billion (US$15.66 billion) target. And a whole series of funds, the Blue Economic Zone Industrial Investment Fund, the Huayu Water Industry Investment Fund, the Shanghai Automobile Industry Fund, and Sichuan Industrial Zhenxing Development Investment Fund are all after around RMB30 billion apiece. There is even a China Cultural Industrial Investment Fund – targeting RMB20 billion.

As the names suggest, these entities seem worlds away from Western-style independent value-driven platforms. Most appear deeply involved with their parent institution. And in China, it pays to have a powerful patron.

But the private equity fund structure, despite the grumbles of many LPs (limited partners) at high management fees, is recognised to work because it incentivises managers to select the best deal on plain financial criteria and achieve top performance from their assets – and even sometimes stripping these rather than take a loss for the investors. Will these new funds do the same? Doubtful. There seems too little separation between them and their targets. The Blue Economic Zone fund appears to be part of a $36 billion+ package to support Shandong’s new coastal development zone, while the Sichuan Industrial Zhenxing fund aims at revitalising Sichuan. The Shanghai auto fund is backed by the China Machinery Industry Federation and Shanghai’s Jiading district government. Few to none appear to have recruited experienced PE professionals. Many are targeting the sectors prioritised in China’s 12th five-year plan. The Huayu Water fund is endorsed by the State Council and the NDRC (National Development and Reform Commission).

The pilot vehicle that these most resemble, the Bohai Industrial Investment fund, has been characterised as “dysfunctional”, hobbled by conflicts of interest. State-backed entities apparently are shoehorning their pet projects or sectors into the latest fashionable funding structure. The motors for PE performance appear missing. Significantly, the China Railway fund seems designed as an alternative funding structure for a ministry rocked by corruption scandals and fatal accidents. Should independent investors care? About competition from these generously funded and potentially indisciplined rivals, then yes. But also about potential reputational and regulatory damage to the entire asset class when, as is very likely, these behemoths turn out to be white elephants.