Rothschild/China: Private equity is taking on Chinese characteristics. The latest riff on the old buyout theme is the birth of funds that raise capital locally in China and then invest it overseas. Given the rapid growth of China relative to the stagnant US and European economies, that might sound muddle-headed. And, the mechanics are rather different from traditional private equity. Still, it's nice work for those with the contacts to get deals done.
Two funds are already passing the cap around. A vehicle backed by Jacob Rothschild’s RIT is one; A-Capital, a Euro-Asian fund, is another. Between them, they are targeting some $1.2 billion of fundraising.
Both are betting they can overcome the onerous red tape involved in converting China’s closed currency. Getting funds into the country can take months, though the foreign reserves guard-dog may be more relaxed about capital flowing out.
What the funds are proposing seems more akin to matchmaking than traditional private equity. Leverage isn’t a factor.
Instead, the main draw is in offering state-owned enterprises and local corporations a vehicle through which to take minority stakes in strategic foreign companies, without the execution risk that comes with doing it themselves.
That could appeal to Chinese firms still smarting from memories of miner Chinalco’s slapdash purchase of a stake in miner Rio Tinto in 2008.
Taking on Chinese investors brings snags. Few wealthy investors want to lock their money for long periods.
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One way around that is to offer co-investment options, where those who put money in the fund can invest more in specific deals, without the onerous lock-up restrictions. Even so, there's the risk that investors simply decline to honour their commitments.
If China’s currency started appreciating decisively, it might be hard to part investors from their yuan.
But the funds are still on to something. While China’s growth is rapid, there are few bargains to be had at home. Widening concerns about credit quality and accounting standards may prompt more investors to look west.
More important, Chinese investors are still prepared to pay a two per cent annual management fee, and 20 per cent — or more — of any upside. For private equity managers, it will be reassuring to note those generous incentives haven’t got lost in translation.