Beijing hasn’t shirked in its efforts to create a domestic private equity industry. It has drawn up laws for renminbi funds, Tianjin has been anointed a private equity breeding ground, and now financial institutions are gradually being allowed to join in the party.
It was therefore little surprise when China’s National Social Security Fund (NSSF) announced that it was increasing its private equity focus.
"They’ve got cash, they got bonds, they’ve got equity and they’ve got overseas equity, so why not add some private equity?" said Stuart Leckie, chairman of consultancy Stirling Finance
As of 2007, 47% of the NSSF’s investments were in discretionary investments including private equity. The full value of the fund reached US$202.46 billion by 2008.
Private equity tends to a better long-term performer than public equities such as stocks, according to Bob Partridge, Far East transaction advisory services leader at Ernst & Young. Better performance is what the NSSF needs. In 2008, the fund posted its first-ever annual loss – of US$5.77 billion – from a profit of US$19.87 billion in 2007, blaming a slump in the local stock market.
The NSSF’s involvement in private equity is more than just about better returns, however: Where the fund goes, other investors – and even investment targets – may also benefit.
Flexible yet cautious
As China’s pension fund of last resort, the NSSF can make investments with a long-term maturity schedule. This allows it to take advantage of hybrid structures, such as a combination of debt and private equity, which are not an option for pension funds or other investors called on to make redemptions on a regular basis. The fund is therefore more flexible than many of its Western counterparts.
The NSSF is also a cautious investor, taking anywhere from 18 to 36 months before committing to a project. In this way, it can ensure that proper due diligence has been conducted and that government regulatory requirements are met.
All these practices are a boon to smaller institutional investors.
"If you’re a mid-range insurer who doesn’t really have the resources to answer the question ‘Should I be in this investment?’, seeing NSSF [there] can give you a lot of comfort," said Michael McCormack, executive director of Z-Ben Advisors.
The fund has been as conservative in private equity as in its other ventures, making small investments over several years: US$147 millon in the China-Belgium Direct Equity Investment Fund in 2004, US$146.57 million in the Bohai Industrial Fund in 2006 and US$293.13 million each in CDH and Hony Capital in 2007. But as it develops its appetite for risk, the NSSF is looking to work with experienced fund managers.
In April, the fund said that it would consider investing in unlisted state-owned enterprises (SOEs). It has also received Beijing’s approval to take stakes in China Development Bank and Agricultural Bank of China as part of their restructuring programs.
Beyond SOEs, McCormack said that since many of the private equity funds the NSSF currently works with are infrastructure-focused, the fund may also be heavily investing in that sector.
That might be just what the economy needs. Private equity firms working with the NSSF can provide more than just money management services. They also provide advice to investment targets on everything from internal processes to corporate management – anything to boost returns.
"[Private equity firms] can invest into the industries that can really help the economy recover," said Steve Li, a partner with Arsenal Capital Partners.