Worsening Sino-American political relations has taken its toll direct-stake China funds, and it remains unclear when institutional interest - of any sizable amount - will be rekindled.
"Large, sophisticated investors are staying low for now .... unless there is a very compelling case to justify such an investment" in China, said Gary Kominski, a director of RogersCasey in Darien, Conn.
A series of political, social and economic disputes worsened relations between China and the United States and spurred concerns of institutional investors. That brought a drop in the number of new private equity funds being rolled out for China. According to Ian Wilson, editor of Micropal Emerging Market Fund Monitor, Glen Allen, Va., investment managers are now creating fewer China funds than at any time since China began its growth surge in the early 1990s.
According to Micropal's data, at the end of 1991, there were four direct-stake China funds with total assets of $110 million. Those figures jumped to 34 funds with $1.3 billion of assets at the end of 1992. By the end of 1994, 73 China funds had assets of $4 billion; and as of the end of last year, 99 funds held $5.9 billion of assets. In this year's first quarter, there was a net gain of one new fund - two were established and one was liquidated - and assets totaled $5.8 billion.
Moreover, some of the existing China funds have been slow to invest the assets they have. For instance, at year-end 1995, Micropal's universe of 35 direct-stake China funds, with assets totaling $2.42 billion, held $850 million in cash - meaning that almost one-third of the assets had not been invested.
As one consultant summed up: "The notion of investing in a country that uses slave labor, pirates intellectual property and fires missiles into the Taiwan Strait might be a hard sell right now to a pension fund board."
James E. Bayne, manager-benefits finance and investments of Exxon Corp., Irving, Texas, agreed. He said direct investments in China by the $3.8 billion pension fund "are not a priority for me. Even if there were a fund I liked, the amount of money we could invest in it would be too small" to make it worthwhile.
"Enthusiasm has cooled a bit from the euphoria of about three years ago," said Peter M. Gilbert, chief investment officer of the $16.8 billion Pennsylvania State Employes' Retirement System, Harrisburg. Mr. Gilbert said his fund is not yet prepared to make investments in China.
Such cautiousness contrasts with attitudes of two to three years ago. Then, evidence of accelerating economic growth and modernization in China spurred the creation of funds for direct investment in Chinese companies or for infrastructure development in China. (Often, investments in China also were included in the growing number of broader investment funds for Asia.) Some investors saw China, with its 1.2 billion people, as a gold mine of opportunity.
But after the initial burst of interest in China funds, sobering reality began to set in. An array of problems surfaced: tightened monetary policy, which eventually affected profits of Chinese companies as well stock market returns; heightened concern over leadership issues as Deng Xiaoping's health reportedly declined; and worsening international political relations.
About a year ago, China's relations with the United States noticeably declined. Triggering that downdraft was the permission given Taiwan's President Lee to make a private visit in the United States.
"What I'm hearing and reading is that it's taking a long time for (at least some) managers of these funds to get comfortable with investing in a country with poor accounting practices" and ample "bureaucracy and red tape," said Mr. Wilson.
But some money managers say the tide of opinion against China may be starting to turn. In any case, managers with superior reputations have continued to attract investment interest in their funds.
Among the favorably mentioned are such firms as HSBC Private Equity Management Ltd. in Hong Kong. According to David L. Conrod, a director of HSBC Asset Management Americas in New York, HSBC Private Equity Management has eight funds for Asia, including three targeted solely for China investments. But the partnerships marketed to institutional investors have all been Asian regional funds, of which there have been three so far. According to Mr. Conrod, institutional interest remains strong in the funds of his firm, which, he said, has Hong Kong's largest team of investment professionals dedicated to Asian private equity investing.
"Our funds invest in manufacturing companies, not in infrastructure projects that can be more prone to political problems because of their high profile."
The firm has raised more than $500 million for private equity investments through seven closed-end Asian funds - not counting a new India fund - and made approximately 60 investments, that total approximately $430 million.
Fund-raising by Bridgewater China Partners, Beijing, a partnership of four U.S.-based organizations, is likely to begin in about two to three months. But because the organization will only be looking to attract about $75 million, including partners' allocations, "I don't think it should be a problem to raise that amount," said Raymond Dalio, president of Bridgewater Associates, Wilton, Conn. His firm is one of the four Bridgewater China partners. In the current climate, Mr. Dalio feels it would be more difficult to raise "big funds of $200 million."
"People who invest in China know they should expect problems," Mr. Dalio said. Over the life of their investment, "American-Chinese relations are likely to improve and deteriorate three or four times, as will economic conditions. China is a place of uncertainty," like other emerging markets in "Mexico, Brazil and Indonesia."
Interest in ValueQuest China fund is picking up again, according to Terrence Mcgrath, president of that Beijing and Marblehead, Mass., organization. "When we started fund-raising about a year and a half ago, we found very good reception," said Mr. Mcgrath. But bad publicity about China took its toll and delayed the expected closing of the fund by about a year.
In the meantime, investment conditions have become more favorable in China. With tightened credit conditions, growing companies were ever hungrier for capital. Those who could supply capital are now finding they can invest in companies at highly favorable terms. This is producing "an absolutely classic buying opportunity" that is helping to renew interest, said Mr. Mcgrath. As a result, he expects to be able to close his fund in at about $100 million in three to four months. So far, the fund has attracted $40 million.
Morever, Micropal's Ian Wilson agrees that China "is probably a good buying opportunity at this point, since there can't be too much more downside risk." Mr. Wilson believes that a big rally in China's still-depressed stock market could occur within the next year. And when it comes, prices in this small market could jump 30% to 40% in a short time. Such a move could refocus attention on China's perceived long-term opportunities - including those obtained through direct-stake investing.
