Beijing-backed tech funds with nearly $ 900 billion under management are struggling to meet their profit targets, according to executives who say their capital is tied up in companies that can’t launch initial public offerings and don’t. are not attractive to investors.
“The traditional exit strategies of private equity funds don’t work well for us,” an executive from 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 named.
Since its creation 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 shed stakes in two-thirds of its companies by wallet.
These range from agricultural machinery manufacturers to social media sites, many of which barely make ends meet. As a result, ZSI is unlikely to meet its six-year divestiture deadline in December.
ZSI is just one of thousands of Chinese government guidance funds, or GGFs, that may not be able to liquidate their investments on time. GGFs, which operate as private equity funds, represent one of Beijing’s most important efforts to foster local innovation as the US-China rivalry reduces the amount of Western technology available to the world’s second-largest economy.
The initiative has come under intense scrutiny, however, as GGF’s policy-driven investment strategies and market-based performance targets clash.
“There’s going to be a real math 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 take off until 2014, when the state council announced plans to aggressively develop the industry to address the lack of funding for start-ups. technological ups.
The initiative aimed to replace direct government subsidies, which Beijing began cutting in the mid-2010s, when the practice came under pressure to be ineffective and undermine fair competition.
This led to a boom in GGFs, whose capital came from central and local budget budgets. Chinese provinces and cities hoped that the investment vehicles could form industry champions.
At the end of March, China had 1,877 GGF managing a total of Rmb 5.7 billion ($ 892 billion), according to Zero2IPO, a Beijing-based consultancy. A decade earlier, there were 71 funds with Rmb83bn under management.
“GGFs are one of the largest and most active players in China’s private equity industry,” said Li Lei, executive of a Beijing-based GGF. “No one can compete with the resources of governments.”
The investment boom has breathed life into some local businesses. Nio, a once struggling electric vehicle maker, experienced a change of fortune after receiving a Rmb7 billion investment last April from three GGFs. Shares of the New York-listed automaker have since risen more than 10 times, with the firm reporting increased sales.
The successful bet on Nio, however, followed many failures. Public records show that Chinese GGFs withdrew less than a quarter of portfolio companies that had received funding for more than six years. This has put many funds, which are nearing the end of their lifecycle, under pressure as they struggle to execute their exit strategies on time.
As with PE funds, most GGFs are structured on a fixed term basis so that their capital can be reallocated to new investments.
“I can’t think of a quick fix to the problem given our flawed business model,” said Li, who faces a December deadline to part with seven companies.
Poor investment decisions are partly responsible for the exit delay. Most GGFs, especially those funded by local governments, face geographic and sector restrictions on where they can allocate their funds. Such demands are driven more by political priorities than by commercial logic and have given rise to many underperforming investments.
Li said his fund, backed by the Beijing municipal government, was mandated to invest at least 70% of its money in specialty chemicals and advanced manufacturing companies in the capital, where these industries are under. -developed.
“We had to buy from unqualified companies to meet the quota,” Li said. “This had a negative impact on the results of the investments. “
To improve their performance, many GGFs have shifted their start-up-focused investment strategy to focus on established companies seeking an IPO, the traditional exit channel for private equity funds.
The pivot, however, has been compromised by Beijing’s decision to tighten public listing clearances this year to protect investors. Official data showed that nearly half of IPO applications on the Shanghai and Shenzhen stock exchanges failed in the first four months of this year.
“We have lost hope of divesting ourselves through IPOs given the tightening of regulations,” said Wang Zhi, investment director of a GGF based in Zhejiang province.
With few other options and with liquidation deadlines approaching, some GGFs have decided to offload their investments with lower than expected profits or even incur losses. In April, Wang’s fund sold a stake in a local machine tool factory it bought five years ago for a 20% gain, a low return by industry standards.
“Our priority is to achieve political goals and prevent the loss of state property,” Wang said. “We are not a market-based entity that only cares about returns on investment.”