China PE and mutual funds: Never the twain shall meet

China's sunshine funds have found themselves amongst the clouds. Earlier this year, the vehicles, which raise private capital to invest in listed companies, won approval to operate in the mutual funds space. The China Securities Regulatory Commission (CSRC) saw it as a means of opening up properly marshaled retail capital-raising channel for the sunshine funds while simultaneously promoting the development of the fund management industry as a whole.

Then the National Development and Reform Commission (NDRC) nixed the plan, reminding private equity managers that they are prohibited from running retail funds and investing in publicly traded securities. It is the latest in a series of skirmishes between the CSRC, private equity's would-be regulator, and the NDRC, its de facto regulator, in their battle for oversight of the asset class.

The CSRC's broad objective is to widen the range of mutual fund platforms available over the next 5-10 years, and it wants private equity firms, securities companies and insurers to participate.
"The CSRC wants to see private equity become an asset class in which ordinary investors can invest and become limited partners," explains Michael McCormack, executive director at Z-Ben Advisors, a Shanghai-based financial services consultancy. "Individuals make up 80% of the investor base in China and they have limited choices through which to diversify their holdings."

Indifferent attitude

The mutual fund industry is indeed a big beast, with assets under management increasing 30% over the course of 2012 to RMB2.8 trillion ($452 billion), the best performance in four years. But are private equity managers interested in participating? The general consensus appears to be "not particularly."

"We would like to stay where we are and focus on our core business," says Margaret Huang, managing partner at Shenzhen Fortune Venture Capital, which has been in operation for 13 years and raised at least 12 private equity funds.

First and foremost, the majority of renminbi-denominated private equity firms are hardly in a good position to market themselves to potential retail investors. The industry raised a huge amount of capital from high net worth individuals, in many cases promising handsome returns within three years via public market exits. Given that the IPO approvals have been suspended since the middle of last year, managers are struggling to return money to investors. Sentiment towards the asset class is weak.

Just as significant are the fundamental differences in approach between private equity and mutual fund managers - entering the industry would require the recruitment of brand new teams and this is beyond the means of many firms, at least for the time being.

"I don't think private equity players are ready to setup mutual funds," one renminbi fund-of-funds manager tells AVCJ. "It is just so different in terms of business model, development strategies, corporate culture, team building, skill sets and market research."

Vincent Huang, a partner of global fund-of-funds Pantheon, who is also involved with the Limited Partner Association of China, concurs that the gulf in strategy is too wide to be bridged at present. The liquidity requirement between the two is very different, with public market investors operating by the quarter - or at most by the year - as managers normally face a redemption requirement. PE funds, on the other hand, are subject to lock-up periods of as long as 10 years.

However, the biggest challenge for prospective private equity entrants to the space would be distribution. China's mutual fund industry is likened to a giant supermarket, the shelves lined with products and banks' wealth management consultants pace the aisles pitching whatever generates the most fees. It is in stark contrast to the personal networks through which PE managers have raised their vehicles.

Furthermore, attempts to build out distribution platforms might trigger a series of conflicts of interest as time and resources are devoted to new business ventures rather than managing existing funds on behalf of LPs.
"It is like the Great Wall, you can't jump over to another side," a global gatekeeper says, illustrating how it would be difficult for a private equity model and a mutual fund model to co-exist. "It involves company interest and internal integration among senior management from both teams."

On the undercard

Since the NDRC voiced its opposition to the plan, neither it nor the CSRC has offered additional comment. As it stands, securities firms and insurers are preparing to debut mutual funds next month, with private equity players conspicuous by their absence.

What is especially curious about this episode is that minimum asset base and paid-in capital thresholds of RMB3 billion ($485 million) and RMB10 million proposed by CSRC as a precondition for participation in mutual funds would exclude the vast majority of private equity firms. It is estimated less than 10 would qualify, led by the likes of Hony Capital and CDH Investments.

So why was the NDRC so trenchantly against the plan, going so far as to say it would name and shame any firm that violated the prohibition order?
It comes back to the regulatory turf war with the CSRC, with each agency seeking to recruit private equity firm into its affiliate industry associations. Needless to say, a sunshine fund wouldn't be able to enter the mutual fund space without first joining the Asset Management Association of China, which has closer ties to CSRC. The tensions do little to promote the broader funds management industry.

"Someday in the future, if NDRC decides that issuing mutual funds would be good for the industry, it would coordinate with the CSRC to develop detailed regulations. However, that is not happening now, nor do we expect to happen in the near future," Z-Ben's McCormack says.

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• Topics
• Investments
• Fundraising
• Greater China
• Regulation
• China
• regulation
• NDRC
• CSRC
• Shenzhen Fortune Venture Capital
• Pantheon