Growing investment into China’s fledgling private equity market by short-term-orientated high-net-worth individuals is at risk of damaging the segment even before it gets off the ground, warn industry figures.
By the end of last month there were 2,591 high-net-worth limited partners (LPs) in China, representing 47.1% of the total number of LPs in the country, according to Zero2IPO, a private equity research firm based in Beijing.
This figure has grown from 1,866 high-net-worth LPs at the end of the first quarter last year and 2,272 at the end of December.
Yet the aggregated committed capital of high-net-worth LP investors stood at just $5.17 billion by the end of last month, or 0.7% of the entire investible capital pool for limited partners in China.
Amanda Liu, an analyst at Zero2IPO, points out that this pool of high-net-worth LP money is highly fragmented, with many players having invested small sums.
“Most of it is idle money from affluent individuals that is being invested into private equity in a personal wealth management-style approach,” she explains. “These investors are largely backing small PE funds and for the most part do not have a long-term investment plan.”
This deluge of non-professional money is leading to a proliferation of unsophisticated investment, agrees Juan Delgado-Moreira, Asia managing director of PE asset manager Hamilton Lane.
“This private individual money is not being channelled into the highest quality funds but is being used to create new funds managed by people who don’t have the skill-sets,” he suggests.
It is understood these small PE funds are largely targeting pre-IPO deals, driving up the valuation of entry targets in the process and intensifying competition in the PE market, particularly for RMB private equity funds.
“Since PE is still at a relatively early stage of development in China, if these newcomers commit funds to new managers who, in my opinion, have a 90% possibility of failure, that entire wealth management group will conclude that PE does not work,” says Delgado-Moreira. “This will create a sense that PE [investment] is fraudulent and this is worrying.”
Multiple sources note that many general partners backed by high-net-worth LPs have failed to deliver targeted investment returns and consequently have been unable to raise subsequent funds.
In part this is driving greater institutionalisation among individual LPs in China, who after suffering disappointments are turning to more professional PE investment managers.
Shanghai-based private wealth management firm Noah Holdings launched the first RMB private equity fund of funds (FoF) in China in 2010. Through this, individual clients can gain access to PE investment with smaller sums, while diversifying into up to 10 PE funds at the same time.
“The FoF idea emerged from taking into account HNWI clients’ overall asset allocation needs,” says Yin Zhe, Noah’s chief product officer.
“Where we add value is to actively adjust the portfolio to ensure diversification of different managers’ investment styles and the sector distribution/coverage of portfolio companies.”
But while FoFs may be a viable channel for PE investors, at this initial stage they face difficulties in raising funds in China, where they are still a novelty.
“Due to the double layers of fees and the fact that it is a new concept, it is taking time for FoFs to be widely accepted by HNWIs in China, who still lack sophistication,” notes Yin.