LPs want stability plus innovation from Chinese GPs - AVCJ Forum

"It is hard to find any manager in China where, over more than two fund cycles, the key man team or strategy has remained the same," Sally Shan, a managing director at HarbourVest Partners, told the AVCJ China Forum. "You can't just keep re-upping. In the US you can go into Fund X and not worry about them doing anything different. But in China, if you don't change you may fail."

Shan's approach is to evaluate every manager as if backing them for the first time. And commitment decisions must be made in the expectation of change – in terms of personnel, target sector, or a private equity firm growing too big too fast and expanding beyond its core competency.

These dynamics inevitably mean investors have less to work with when assessing GP track records. At the same time, though, this can liberate them somewhat when considering commitments to teams that are newly formed or have spun out from existing private equity firms or corporate investment units.

Xiaochen Li, an executive director at Beijing Taikang Investment – a subsidiary of Taikang Life Insurance, which has RMB1.2 trillion ($189 billion) in assets under management and a private equity portfolio of RMB20-30 billion – noted that over the course of 15 years China's PE industry had grown from nothing to RMB12 trillion in assets. This speed of development has helped create a complex market, underpinned by a commercial and policy framework that alters every three to five years.

"In general, it's a window of opportunity for LPs because these new funds represent new strategies, new thoughts, and renewed motivation to work extra hard to build reputations from the ground up," Li said of spin-out managers. "We need to think about how we can capture this part of the value and how we can provide support to make sure these GPs contribute to economic growth and technology innovation. On the other hand, trying to evaluate a GP is very complicated in China."

Caisse de dépôt et placement du Québec (CDPQ) also looks at spin-out funds as an opportunity as well as a challenge. The Canadian pension fund has $240 billion in assets, of which $30 billion is in private equity – two thirds in direct investments and one third in fund commitments. Asia accounts for about 5% of the overall PE portfolio. Dave Brochet, a managing director with CDPQ Asia Pacific, noted that backing a spin-out can mean serving as an anchor LP and getting a large allocation to the fund.

At the same time, Brochet stressed that the due diligence process is no different in Asia from developed markets, with the sustainability of track record the primary criterium. "The key question I have for Asian GPs is their capacity to retain talent," he said. "It is something we monitor when tracking potential GPs … so when they do come to market we are informed as to how the team has evolved."

While other investors follow the same assessment protocols, they believe that team turnover should be viewed in the context of China's cultural nuances and the fact that demand for talent far outweighs supply, contributing to the velocity of movement between firms.

For Huai Fong Chew, an investment officer with the International Financial Corporation (IFC), the focus is on senior-level executives. "We see a lot of movement among the junior partners, but in general, if the top stays stable we are not overly concerned," she said. This tallies with the due diligence method described by HarbourVest's Shan, which involves extended face-to-face discussions with GP founders.

"I spent way more time than before evaluating human nature. It means I can predict their behavior more easily than by studying what they have accomplished before," Shan explained. "The soft side of evaluation is increasing, especially because the easy growth is no longer there and understanding the core leadership of GPs is becoming more important."

The objective is to get a sense of the long-term sustainability of a team by establishing what motivates the founder and whether he will retain his drive even after accumulating substantial personal wealth. This inevitably leads to questions about steps taken to build an institutionalized platform that can outlast the founder.

A common criticism of Chinese private equity firms is that the power and economics accrue to a single patriarchal leader. The risk is that failing to establish a deep bench of talent, and incentivizing those people to stay, will see the GP break up after a handful of vintages. While acknowledging the importance of evenly distributed compensation, Shan argued that patriarchs might work better than partnerships in China.

"Maybe part of China's culture does not tolerate that kind of true partnership," she said. "The important factor is the founder has a sound mind and knows to bring in people who have strengths that he doesn't have. There also need to be checks and balances so it's not one person making all the decisions."

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• Topics
• Greater China
• LPs
• Fundraising
• China
• HarbourVest Partners
• Caisse de depot et placement du Quebec (CDPQ)
• IFC
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