JapanÆs institutional investors have long sought ways to diversify into growing emerging markets, to compensate for the low returns from their mature, aging society. China has been the most obvious destination, with Japanese companies using it as a manufacturing platform and, more recently, as a potential consumer market. Institutional investors have been slower to follow, and until now have tapped China mainly through public securities û either as QFII investors or through Hong Kong-listed stocks.

Hong KongÆs First Eastern Investment Group has stepped into the breach, closing a private-equity fund for Japanese partners that will co-invest in a variety of sectors across China.

ôThis is just the beginning of Japanese institutional investment into China, which has always been seen as a high-risk destination but whose potential is enormous,ö says Victor Chu, chairman of First Eastern, a lawyer by training and a fourth-generation member of the family behind the firm. Chu is also chairman of First Eastern Investment Bank and FE Securities, and has served in high-profile advisory positions in Hong Kong institutions such as the stock exchange, the securities regulator and the government.

His family has been investing in China for nearly 50 years, and pioneered direct investment in 1988 by establishing First Eastern Investments û initially with Japanese corporate partners, which were bought out in the aftermath of Tiananmen Square, when it became politically difficult for the Japanese to remain invested.

Initially the firm invested just the familyÆs money, operating across a number of offices in the mainland. In 1992 it expanded when Victor Chu began a private-equity fund to go into China û initially a $20 million portfolio of family and third-party money that is now over $1.5 billion in assets, invested across roughly 100 projects whose total investment size is $5 billion.

ôStrategically, Japan and China relationships are at a turning point,ö Chu explains. Trade picked up under the reign of Junichiro Koizumi, JapanÆs reformist prime minister, but political relations soured. This has been rescued by subsequent rulers, and in the past two years, with Shinzo Abe, Yasuo Fukuda and Wen Jiabao visiting each otherÆs country; on May 8, Hu Jintao will travel to Japan.

ôNow these relationships are complementary,ö Chu says. Although there remain political arguments over things such as resources, the pattern is set: Japanese companies and investors need growth, and ChinaÆs coastal and urban regions are integrated into trade and cultural exchanges with the Japanese.

The rise of China as not only a cheap manufacturing platform but also an attractive consumer market for Japanese companies reflects this warming of ties. Just as Japanese manufacturers took a while to figure out how to build and sell cars in the United States, its companies have yet to figure out how to operate in the Chinese environment, where regulation and business practices are so different and varying.

ôThe domestic market is a whole new ball-game,ö Chu says.

First Eastern will use its China presences and expertise to work with Japanese investors. It is providing capital as a co-investor, with the aim to help both the Chinese and Japanese companies succeed. It will also help Chinese companies explore setting up in Japan.

Its investors are Bank of Tokyo-Mitsubishi, Mitsui-Sumitomo Insurance, Nomura Holdings and an undisclosed life insurer and a government-tied pension fund.

The fund has closed at a little over $100 million, but its project multiplier û the amount of co-invested equity it attracts û is 15x for equity, and for each dollar of equity it can borrow another $2-$3. So it can ultimately bring up to $1.5 billion to bear, Chu reckons. Its target rate of return on investment is 25% on an annualised basis.

Chu says the negotiations took about 18 months. The delays were due in part to Japanese investorsÆ hesitations, but also because First Eastern was involved in the Richard Branson-led consortium to acquire Northern Rock, which the British government ultimately rejected.