Already hit hard by Covid-19, China-focused private equity strategies are facing rapidly worsening conditions to raise funds as Sino-US tensions ratchet up to new levels and a case of fraud at private equity-backed Chinese company Luckin Coffee undermines investor confidence.

Some private equity fund managers, also known as general partners, are looking at cutting their fees to attract more investors. But such efforts are seen as unlikely to sufficiently offset growing investor concerns, particularly with smaller GPs. Only the bigger, better established private equity players look set to weather the turmoil relatively well.

The pandemic has made capital introductions harder, in light of travel restrictions, slowing economies and greater uncertainty. That is likely to cause fundraising volumes to fall in the coming months as managers reduce targets or extend capital-raising periods, said consultancy bfinance in a report this month.

In addition, private equity funds from China might be shunned by international investors due to growing tensions with the US over the pandemic and its aggressive moves towards Hong Kong, a Hong Kong-based private placement executive told AsianInvestor on condition of anonymity.

GPs are having to consider the ramifications of a mounting campaign by Washington for US public institutions to not invest in Chinese assets, along with President Donald Trump's increasingly aggressive blaming of Beijing for the coronavirus outbreak. In addition, on Wednesday (May 20) the US senate passed legislation that could prevent some Chinese companies from listing on American exchanges. It applies stricter reporting rules to all foreign companies but is seen to be targeting Chinese firms in particular.

China, for its part, unveiled on Thursday (May 21) plans for a national security law for Hong Kong that would undermine its semi-autonomous status. That led US senators to reportedly introduce a bill that would sanction Chinese officials and entities who enforce the new national security law and penalise banks that do business with entities linked to it. 

This increasingly bellicose back and forth arrived on the heels of an accounting scandal at Beijing-based Luckin Coffee. The company – which was backed by Chinese private equity firm Centurium Capital – admitted last month to falsifying Rmb2.2 billion ($300 million) in sales last year.

A case of rampant fraud in a private equity-backed Chinese company is very likely to sap investor confidence over investing more into the country, particularly given the rapidly worsening political tensions and ongoing ramifications of the coronavirus. 

“[When] you get stuff like [China’s] Luckin Coffee, with a GP that people respected, [then investors might be wondering] if they can’t get it right, what else is going on there?” said the unnamed capital placement executive.

“Centurium [Capital] … definitely screwed up, and if you screw up, you are definitely going to be punished in this environment,” he added.

LITTLE INCENTIVES

Some PE firms hope that by offering incentives, such as reductions in management fees, they can help encourage more long-term minded investors to give them capital in the difficult Covid-19 environment. But there are doubts over how much of an impact such moves will have.

Certain GPs are giving investors "several" basis points of reductions on the management fee for their funds’ first or second close, while others are offering similar discounts for the first year of commitment, the unnamed Hong Kong-based placement agent executive said. He did not provide examples of the size of discounts.

“It’s a tiny carrot to ask LPs [limited partners, or investors] to complete their work quicker; that’s all,” the executive added.

Indeed, such incentives may not be sufficient to draw in more investors, especially as many have turned more selective on making private equity fund commitments to since the outbreak started.

Mounir Guen

“[The offering of incentives] has been around for as long as I can remember, but it doesn’t help you if the fund doesn’t go anywhere,” said Mounir Guen, Hong Kong-based chief executive of placement agent MVision. “At the end of the day, it’s more symbolic than anything.”

He added that most investors had already decided their commitments to fund managers for this year.

GROWING BIFURCATION

New and smaller managers, in particular, are expected to struggle in this environment. 

New fund managers would find it hardest as they don't yet have a track record, said Robert Woll, Hong Kong-based partner of law firm Mayer Brown.

In contrast larger and better-established fund managers look set to find it far easier to keep raising mega-funds. 

While this bifurcation was already taking place before the virus became a pandemic, the current investing climate seems likely to exacerbate the divide. For instance, Beijing-based Hillhouse Capital is reportedly targeting $12 billion to $13 billion for a fifth fund after closing its fourth at $10.6 billion in 2018. It has the advantage of being well-known, with a track record. 

“Hillhouse just launched a [huge] new fund … and I am sure they will raise it,” the placement executive said, “so they are a brand that will be a winner.

“Maybe fundraising for a new Chinese fund will be hard, but in that context, is Hillhouse going to be affected?" he added. "No, they are going to raise the money.”