Beijing-backed technology funds with nearly $ 900 billion in assets under management are struggling to meet their profit targets, according to executives who say their capital is in companies that can’t go public and are unattractive to investors.
“Traditional private equity fund exit strategies don’t work well for us,” an executive at Zhongyuan Science Innovation Venture Capital, a government-backed mutual 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 refused to be named.
Since it was founded in 2015, ZSI, which has invested in more than a dozen start-ups in one of the poorest provinces in China, has not been able to sell shares in two-thirds of its portfolio companies.
These range from agricultural machinery manufacturers to social media sites, many of which can barely make ends meet. Therefore, it is unlikely that ZSI will meet its six-year divestment deadline in December.
ZSI is just one of thousands of Chinese Government Advisory Funds (GGFs) that may not be able to liquidate their investments in a timely manner. GGFs, which act like private equity funds, represent one of Beijing’s most significant efforts to promote its own innovations as a rivalry between the US and China presses the amount of Western technology available to the world’s second largest economy.
However, the initiative has come under scrutiny as the policy-driven investment strategies of the GGFs and the market-based performance targets conflict.
“There will be real settlement with government advisory funds,” said Andrew Collier, managing director of Orient Capital Research in Hong Kong.
While Chinese GGFs emerged in the early 2000s, they didn’t start until 2014 when the State Council announced plans to aggressively expand the industry to combat this Promotion of tech start-ups Defect.
The initiative was intended to replace direct government subsidies, which Beijing began to cut back in the mid-2010s when the practice came under pressure to be inefficient and undermine fair competition.
This led to an increase in GGFs whose capital came from central and local financial budgets. Chinese provinces and cities hoped the investment vehicles could create industry champions.
At the end of March, China had 1,877 GGFs which, according to Zero2IPO, a Beijing-based consultancy, were managing a total of Rmb 5.7 trillion ($ 892 billion). A decade earlier, 71 funds were managed with Rmb 83 billion.
“GGFs are one of the largest and most active players in China’s private equity industry,” said Li Lei, an executive at a Beijing-based GGF. “Nobody can compete with government resources.”
The investment boom has breathed life into some local businesses. Nio, a once ailing manufacturer of electric vehicles, had a change in luck afterwards Receipt of an investment of 7 billion Rmb last April by three GGFs. The shares of the New York-listed auto company have since risen more than ten-fold as the company reported a surge in sales.
The successful one Bet on Nio, however, numerous failures followed. Public records show that Chinese GGFs have disbursed funds from less than a quarter of portfolio companies that had received funding for more than six years. This has put pressure on many funds nearing the end of their life cycle as they struggle to execute their exit strategies in a timely manner.
As with PE funds, most GGFs have a fixed-term structure so that their capital can be reallocated into new investments.
“Given our flawed business model, I can’t think of a quick fix to the problem,” said Li, who has a December deadline to sell seven companies.
Bad investment decisions are partly responsible for the exit delay. Most GGFs, especially those funded by local governments, have geographic and industry restrictions on how their funds are allocated. Such requirements are driven more by political priorities than business logic and have resulted in numerous underperforming investments.
Li said her Beijing municipal government-backed fund has a mandate to invest at least 70 percent of its money in specialty chemicals and advanced manufacturing companies in the capital, where such industries are underdeveloped.
“We had to buy into unqualified companies to meet the quota,” said Li. “That weighed on investment results.”
To improve performance, many GGFs have changed their start-up-driven investment strategy to focus on established companies looking to go public, the traditional exit channel for private equity funds.
However, the fulcrum was affected by Beijing’s decision to Stricter approvals for stock exchange listings this year to protect investors. Official data showed that nearly half of the IPO applications on the Shanghai and Shenzhen stock exchanges were not processed in the first four months of this year.
“In view of the tightening of regulations, we have given up hope of a sale through IPOs,” said Wang Zhi, investment manager at a GGF based in Zhejiang Province.
With few other options and liquidation deadlines approaching, some GGFs have decided to outsource their investments with lower than expected profits – or even accept losses. In April, Wang’s fund sold a stake in a local machine tool factory he had bought five years ago for a profit of 20 percent, a low return for the industry.
“Our priority is to achieve the political goals and prevent the loss of state assets,” said Wang. “We are not a market-based company that only cares about investment returns.”