Beyond the comfort zone: RMB GPs and US dollar funds
An increasing number of Chinese GPs that made their names in the renminbi space are looking to raise US-dollar funds. It requires a level of institutionalization that most have never seen before
After three years and about 12 renminbi-denominated funds, JD Capital - formerly known as Jiuding Capital - raised its first US dollar fund in 2010. The firm, having surprised many with its aggressive domestic pre-IPO strategy, received commitments totaling $120 million. LPs included a string of fund-of-funds, plus Temasek Holdings-owned Vertex Ventures, German insurer Allianz and the BMW Foundation.
JD has now returned with a successor vehicle, which has a target of $200 million and is expected to reach a final close in the next few months. Vertex and Allianz are among those understood to have re-upped.
According to industry sources, at least 30 more managers who established themselves in the local currency business have launched or are preparing to launch debut US dollar funds. A few more, JD among them, are back in the market for second funds. They are typically the private equity affiliates of Chinese banks, corporations and hedge funds, but there are a few independents in the mix as well.
Not everyone gets a smooth ride. "A lot of fund managers with renminbi backgrounds are trying to raise US dollars," notes one renminbi manager who shares their aspirations. "It started last year when the domestic IPO market was shut last year, but it's very hard, particularly if, like us, you are a first time fund."
Those that are capable of closing a US dollar fund could probably be counted on the fingers of one hand. They include consumer-focused Tiantu Capital and hedge fund player Greenwoods Asset Management, both of which are eyeing first closes. Harvest Capital, formerly Sino-Can Harvest Capital (SCHC), has already crossed the line, closing its second US dollar fund last month at $300 million.
Shenzhen Oriental Venture Capital finally continues to preserve and is now nearly a first close of $50 million, having set a target of $100 million for a fund that launched in 2010. Fund-of-funds and family offices are the major contributors. Plenty of others have abandoned similar plans or put them on hold due to a lukewarm response from offshore investors.
Times of transition
Approaching US dollar LPs requires a completely different approach to what renminbi managers are accustomed to in the domestic market. The professionals sitting on the other side of the table usually have clear in-house criteria for picking the best fund managers. With little track record to go by, the LPs must answer the following question: Is this just a one-off, speculative effort, or is this GP ready to create a sustainable US dollar business?
"The real learning process only starts when they seek to establish their first US dollar fund. Few of these renminbi fund managers have a thorough roadmap towards institutionalizing the US dollar fund business. Part of the reason is that they probably only focus on deal making without internalizing what that entails, especially how to interact with sophisticated global institutional investors," says Frankie Fang, a managing director at LGT Capital Partners.
Four years ago these firms had little reason to question themselves. In 2011, renminbi fundraising was at its peak, with about $35 billion going into 261 vehicles, up from $21 billion in 2010.
The likes JD, Shenzhen Fortune Venture Capital and Oriental Fortune Capital were on the crest of a wave. Shenzhen Fortune raised RMB6 billion across nine funds to 2010, while JD had approximately RMB3 billion under management. High net worth individuals (HNWIs) were flocking to these firms in response to stellar pre-IPO plays.
The moratorium on new listings soon put paid to the exuberance. Renminbi fundraising fell from $24 billion in 2012 to $15 billion in 2013, and only 16 local funds have attracted commitments of $3 billion so far this year. Investors lost interest when the promised returns didn't materialize and the already fragmented pool of individual capital for which managers were competing dried up.
"Individuals are not a sustainable source of capital," says one Chinese fund manager. "When we make a capital call for the fund, they simply say, ‘Sorry, I don't have enough money now.' It's also difficult to ask China enterprises for money because their financial results might deteriorate as the overall economy slows. It's hard to survive relying only on domestic LPs."
Some have gone out of business but others have survived. They are looking to raise capital from more reliable offshore sources and diversify their LP bases, but talk is much easier than execution. For many GPs, fundraising means networking with HNWIs at friends' dinner parties.
"I would describe raising money internationally as coming down to how ready the renminbi fund managers are to be transparent. If an LP asks a question and the fund manager says, ‘Give me two weeks to get back to you,' that is going to cause delays in the fundraising process," says Conrad Yan, a partner from Campbell Lutyens.
Cultural differences and communication skills are classic obstacles. These managers do not have the advantages of Hony Capital and CDH Investments, whose founders had worked overseas and could claim a familiarity with the Western institutional mindset. As a result, they are perceived to be less well organized.
"I heard plenty of stories of good fund managers with good track records going on a road show and meeting potential LPs in overseas markets. The fund principal and placement agent are there, but throughout the meeting the principal doesn't say a word," observes Lorna Chen, a partner with Shearman & Sterling. "No matter how good track the record is, if they can't communicate well or correctly to the potential LPs, it's no use."
International LPs evaluate renminbi GPs in much the same way as US dollar managers: they want to see a consistent value creation strategy that can be supported by performance numbers. The numbers might be there - some domestic managers have earned multiples of 10-20x through pre-IPO deals - but faith in the strategy is not. Managers who rely on multiples arbitrage for returns tend to have difficulty differentiating themselves from the mainstream. There is no value creation narrative.
"When you are approaching US dollar focused LPs and you show them a $100 million fund portfolio with 25 investments - each one a small ticket investment, with a short holding period and majority are pre-IPO type of investments, the overall level of interest may be quite limited. You may have been able to generate relatively high IRRs but it's not a very compelling story to tell to the international LPs," says Vincent Ng, a partner at Atlantic-Pacific Capital.
GPs don't help themselves by pursuing more specialist strategies in an opportunistic, almost haphazard, manner. There is a go after whatever sector is currently in vogue, regardless of whether they have sufficient domain expertise.
Inspired by the recent telecom, media and technology (TMT) boom, renminbi survivalists have sought to leverage the enthusiasm for Chinese technology companies listing overseas - such as e-commerce players JD.com and Alibaba Group - by following a similar investment thesis. And they need US dollars to do it.
"When we met some renminbi GPs and asked them which sectors they will invest their new funds in, many said TMT but when we looked at their investment portfolios, there was no background for doing that. It doesn't make any sense to us," says Ally Zhang, managing director at Siguler Guff.
LPs also need to be convinced that managers can resolve the corporate governance issues that arise when operating US dollar and renminbi funds. The LP base for each vehicle is different and internal resources must be deployed in a manner that ensures an alignment of interest with every investor. It is not an impossible task - Hony and CDH are among those that handle it - but transparency is paramount.
"These emerging fund managers have done a lot of pre-IPO investments and some are not suitable or not open to US dollar investments. Sometimes picking US dollars to invest may slow down the process. In that context, when you have a good investment, from which fund will you allocate capital?" asks an international LP, who has backed one renminbi fund.
Same bed, different dreams
Even if a local manager presents a compelling investment narrative and impresses the LP, there is no guarantee that an allocation will follow. A fund with a $200 million corpus may simply be too small for an LP with a minimum check size and a maximum permitted exposure to a single entity. Beyond that, the risk-return profile might not be a good fit.
Fund-of-funds, which have on-the-ground resources that allow them to take more calculated risks on managers with little or no track record, are a good starting point. Family offices may also take an interest.
Shenzhen Fortune Venture Capital, however, went even closer to home. The firm raised $75 million for its first US dollar fund in 2010, when renminbi fundraising was at its peak, and more than half of the investors were existing LPs in renminbi vehicles, who had US dollar assets to invest.
"We raise US dollar fund because we want to attract more institutional investors," says Margaret Shao, managing director at Shenzhen Fortune. "It's easier to start raising capital from our existing LPs who are comfortable investing in us. Asia-based fund-of-funds, insurance or family offices with offices in Hong Kong or Singapore are also more accessible for us because we can communicate in Chinese and they are more familiar with the local markets."
Shenzhen Fortune has yet to finish deploying its first fund and Shao is cautious about returning to the market for a second vehicle. The renminbi business is where the firm's expertise lies and it will remain the key element.
The small and focused approach may work for Shenzhen Fortune, but JD has its sights set higher. The firm wants to become a "mega asset management" firm by aggressively diversifying its business across multiple platforms. This includes offering co-investments to LPs.
According to sources familiar with the situation, this was part of the rationale for Vertex backing JD in the first place. One of the co-investments from the first US dollar fund was Wuxi Huadong Heavy Machinery. Vertex owned a 28% stake in the company prior to its IPO in 2012.
"Vertex tends to do more direct investments. It invests in the fund to access more co-investment opportunities in China," one LP says.
Raising a US dollar fund represents a step into the unknown for renminbi fund managers and it could prove to be a key step if they are to establish familiarize themselves with international capital markets and ultimately become larger scale, global players. The expectation is that US dollar funds will remain relatively modest in size over the next five years, ranging from $100-300 million, as it takes time to build up their domain expertise.
Based on the speed at which the domestic market is maturing to embrace new deal structures and strategic approaches, the current gap in terms of culture, experience and understanding is by no means unbridgeable.
"Professionals in this market are very quick studies: the strategies, what to say, and how to adjust all happen quickly," says Chris Lerner, head of the China practice for Eaton Partners. "A fund that called itself a pre-IPO manager two years ago, now says it focuses on trade sales. The issue is grasping what they really do - not what they say they do - and how that is institutionalized across the team into a repeatable formula for success."
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