Several international private equity companies that invest in China are starting to establish new funds in the Chinese currency, a move that goes against the trend of declining global demand for bets on Chinese startups. The appetite for allocating capital to China-focused funds has decreased in the past year, due, among other things, to the tensions between Beijing and Washington, higher interest rates in the US and stricter regulatory measures by the Chinese government against Internet companies, previously a hot field in the country.
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Capital raisings in dollars by China-focused private equity funds fell by more than 80% last year to just over $23 billion, the lowest volume since 2010, according to data from Preqin Pro. Funds denominated in Chinese yuan fared much better – with fundraisings amounting to (the equivalent of) $455 billion in 2022, just 4% less than a year earlier, according to Chinese data firm Zero2IPO.
In October, Greenwich, Connecticut-based L Catterton, which focuses on private equity in the consumer sector, announced its plan to raise the equivalent of $295 million through its new fund in Yuan, which completed an initial round of capital raising.
Schroders Capital, a unit of the British company Schroders focused on private assets, launched four funds of funds in 2020 managing about 3 billion yuan – about 442 million US dollars. The fourth fund is currently in the process of raising capital. At least more Two global money management firms – one a private equity firm focused on the consumer sector, the other a private credit fund – are raising cash for their own yuan funds, according to sources familiar with the matter.
local and international demand
These yuan funds are in demand from local and international investors, and thus L Catterton’s new channel has been able to secure investments from Chinese government-backed funds, private consumer companies and international companies. The global company, which manages more than 30 billion dollars and among its investors is Bernard Arnaud, owner and chairman of LVMH and one of the richest people in Europe and the world, has previously bet on popular Chinese consumer brands such as the Genki Forest beverage brand.
Schroders Capital’s yuan-denominated funds invested in old private equity companies from China such as Sequoia Capital China and Legend Capital. “More and more sophisticated investors are finding that the RMB (renminbi, another name for the yuan currency) market is a good hedge when dollar allocations are slowing,” said John Qian, director of private equity investments at Schroders Capital in China.
Many Chinese private investment companies, which in the past relied heavily on raising capital from entities such as American provident and pension funds, have experienced a decline in demand over the past year. Only about half of the investors in private equity funds commit to continue investing in the next capital raising rounds, said Niklas Amundson, a partner at Monument Group, which is based in Hong Kong and helps private equity companies raise money.
The decision to launch funds in yuan can help private equity funds invest in companies at early stages of their lives. Most Chinese consumer-facing startups only want yuan in the first rounds of capital raising, said Scott Chen, managing partner at L Catterton’s Asia Fund. This provides the fund with the potential to make large profits compared to investors who join in subsequent fundraising rounds. Another advantage of investing in companies that appeal to Chinese consumers in yuan is that most of them eventually seek to be listed on the local A-rated stock market, which trades in yuan, Chen added.
A choice that involves challenges
Schroder Capital focuses on three themes when looking for funds to invest in Chinese startups: consumerism, digital solutions for corporations and import substitution. The latter refers to strategic sectors such as semiconductors, where China is trying to wean itself off its dependence on parts of other countries.
China’s regulations do not restrict dollar financing in the semiconductor sector. But companies in this industry increasingly prefer to receive financing in yuan because they expect a warmer reception in the local market when they list on the Chinese stock exchange.
The choice of yuan involves challenges. Government-backed funds, a vital source of capital, often require money managers to encourage their portfolio companies to invest in the local economy – a practice known in China as “reverse investment”. This is typically agreed upon before any commitment to raise capital. Often the funds also want to invest directly in companies alongside the private equity funds, instead of functioning only as passive investors in the funds.
The latest buzz is not the first time private equity firms have tried to raise and invest in yuan. At the beginning of the previous decade, global giants including the Carlyle Group and TPG tried to raise funds in yuan in order to look for opportunities to purchase or make minority investments in Chinese companies. The results were not good and many of these companies have since stopped having a presence in Yuan or have significantly reduced it.
Some market participants argue that this time will be different because the private equity investment landscape in China has evolved, especially given the growing opportunities to invest in start-ups.
“The type of transactions that were available to giant funds were mostly a non-controlling stake in old companies that, in general, not only in China, it was very difficult to get a return from. Today it is a different set of options,” said Amundson of Monument Group.