Technology funds backed by Beijing with nearly $ 900 billion in management are struggling to reach their profit targets, according to executives who say their capital is locked into companies that can’t launch initial public offerings and aren’t not attractive to investors.
“Traditional exit strategies for private equity funds do not work well for us,” an executive of Zhongyuan Science Innovation Venture Capital, a state-backed investment fund in central Henan province, told the Financial Times .
“Our investment decisions have more to do with political considerations than market principles,” added the executive, who asked not to be called out.
Since its inception in 2015, ZSI, which has invested in more than a dozen start-ups in one of China’s poorest provinces, has not been able to unload stakes in two-thirds of its portfolio companies.
These range from agricultural machinery manufacturers to social media sites, many of which are on the verge of ending. As a result, ZSI is unlikely to meet its six-year lease deadline in December.
ZSI is just one of thousands of Chinese government hedge funds, or GGFs, that may not be able to liquidate their investments on time. GGFs, which operate assimilated to private equity funds, represent one of Beijing’s most significant efforts to nurture home innovations as a US-China rivalry. squeeze the amount of Western technology available to the world’s second largest economy.
The initiative has been under scrutiny, however, as investment strategies driven by GGF policies and market-based performance targets come into conflict.
“There is going to be a real calculation for government guidance funds,” said Andrew Collier, managing director of Orient Capital Research in Hong Kong.
While Chinese GGFs emerged in the early 2000s, they did not leave until 2014, when the state council announced plans to aggressively expand the industry to deal with it. financing of technology start-ups lack.
The initiative was intended to replace direct government subsidies, which Beijing began to limit in the mid-2010s when the practice was pressured to be inefficient and undermine fair competition.
This has led to an increase in GGF, whose capital comes from central and local fiscal budgets. Chinese provinces and cities hoped that investment vehicles could build industry champions.
At the end of March, China had 1,877 GGFs managing a total of Rmb5.7tn ($ 892 billion), according to Zero2IPO, a Beijing-based consultancy. A decade earlier, there were 71 funds with Rmb83bn in management.
“GGFs are one of the largest and most active players in China’s private equity industry,” said Li Lei, a director of a Beijing-based GGF. “No one can compete with the resources of governments.”
The investment boom has given life to some local businesses. Nio, an old electric vehicle manufacturer, had a fortune change later receives an Rmb7bn investment last April by three GGFs. The shares of the listed automobile company in New York have already grown more than 10 times when the company reported a jump in sales.
Success bet on Nio, however, it followed numerous failures. Public records show that Chinese GGFs have outperformed less than a quarter of the companies in their portfolio that had received funding for more than six years. That put a lot of funds, which are nearing the end of their life cycle, under stress as they struggle to execute their exit strategies on time.
As with PE funds, most GGFs are structured at a determined time so that their capital can be reallocated to new investments.
“I can’t think of a quick solution to the problem given our flawed business model,” said Li, who faces a December deadline to shut down seven companies.
Few investment decisions are partly to blame for the exit delay. Most GGFs, particularly those funded by local governments, face geographical and industrial restrictions on where they can allocate their funds. Such needs are driven more by political priorities than by business logic, and have given rise to numerous underperforming investments.
He told them that his fund, backed by the Beijing municipal government, is mandated to invest at least 70 percent of its money in specialized chemicals and advanced manufacturing companies in the capital, where such industries are underdeveloped.
“We had to buy into unqualified companies to meet the quota,” Li said. “This has weighed heavily on investment results.”
To improve performance, many GGFs have changed their investment strategy driven from the start to focus on established firms seeking an IPO, the traditional exit channel for private equity funds.
However, the pivot was compromised by Beijing’s decision tighten stock list approvals this year to protect investors. Official data shows nearly half of IPO applications on the Shanghai and Shenzhen stock exchanges failed to proceed in the first four months of this year.
“We have given up hope of hunting for the IPO given the regulatory tightening,” said Wang Zhi, director of investments at a GGF based in Zhejiang province.
With few other options and liquidation deadlines approaching, some GGFs have decided to discharge their investments at lower profits than expected – or even take losses. In April, Wang’s fund sold a stake in a local machine tool factory bought five years ago for a 20 percent gain, a low return by industry standards.
“Our priority is to meet the political goals and prevent the loss of state assets,” Wang said. “We are not a market-based entity that cares only about return on investment.”