In this edition of China Money Podcast, guest Bruno Raschle, chairman of global fund-of-funds manager Adveq, talks with our host, Nina Xiang. He discusses Adveq’s investment activities and performance in China, how to pick fund managers to back, and his views on the future of the Chinese private equity’s exit environment.
Listen to the audio podcast, or read an excerpt below.
Q: Advep has a number of Fund-of-Funds (FOF) dedicated to Asia. Can you tell us more details about your investment vehicles that can invest in China?
A: We started to commit into China in 1998. We invested primarily in venture funds out of our technology program. In 2006, we started formally an Asian investment fund. Initially, we covered all Asia Pacific, but today we are focusing on India and China primarily.
Currently, we have three U.S. dollar funds dedicated to Asia: a US$217 million fund established in 2006; an US$181 million fund set up in 2008; and a third fund we started raising last year with a target fund size of US$300 million.
China takes up probably two-thirds of our total Asian commitments. Since 1998, we have committed a total of approximately US$400 million in China.
Q: In 2009, Adveq planned to set up a joint RMB fund with Dalian United. How did it go?
A: That plan never got implemented. Over time, we learned that our philosophies were different (from Dalian United’s). We amicably decided to not execute the plan.
Q: For your first Asian FoF, can you give us some examples of the funds you backed?
A: We initially invested in some of the brand names such as Hony Capital, CDH Investment and IDG Ventures. But we also committed to first-time funds. Around 40% of all the Chinese commitments went to first-time funds, including GSR Ventures or Bioveda Capital.
Q: Investing in first-time funds requires a lot of conviction. What would make you believe in a first-time fund manager in China?
A: Investing in first-time funds requires you to be very analytical and bottom-up oriented. Psychologically, you have to read the minds of the managers. You can never make enough due diligence calls. In the end, it is a gut feeling whether you believe a manager can make money for you or not.
Q: How has the mix of funds you invested in evolved over the years?
A: Initially, we committed mostly to local fund managers who were overseas returnees. We generally try to back local managers specializing in a certain industry or field.
We think private equity and venture capital investment in China is still a long-term proposition. That means we like to see managers investing in business models and concepts that are sustainable and can survive disruptions in the markets.
Q: Can you give us an example to demonstrate what you mean?
A: Sure. GSR Ventures invested in Boston Power, a battery company in the U.S. Once GSR had control of that almost-bankrupt company, they brought their manufacturing facilities to China. The company now produces batteries for various non-cyclical industries.
This is a typical example where the fund manager has created the deal, executed it, and made sure that this very challenging undertaking across the Pacific has become successful.
Q: To make one investment, roughly how many funds do you look at?
A: Out of 100 funds that we do preliminary screenings on, we may decide to do deep analyses for about 10 funds. Then we make commitment to one or two funds in the end.
I have been in this business for 30 years, and I’d say this was true in the early phases in the U.S. and Europe, and applies now also to Asia.
Q: What is the most challenging part in your investment decision-making process?
A: Today, it is ESG (Environmental, Social and Governance) compliance and headline risk primarily. You still run the risk where auditors of portfolio companies haven’t done a good job, or a GP doesn’t have tight financial controls over its portfolio companies.
That means we as a FoF have to acquire the knowledge of the underlying portfolio companies in the due diligence and monitoring phases: How they generate revenue, what their cost structures are, in order to validate their valuations. Investors don’t like that headline risk.
Q: For your first Asian FoF, which is in its seventh year, can you tell us how performance has been?
A: The performance of all of our Asian FoF, and certainly the first fund, is very positive. Investors can expect that these funds will be among our very best performing funds among what we have managed in the past 16 years. So far, we have raised 22 FoFs globally.
We have FoFs from almost every vintage year. Some vintage years’ returns are better, and some are less. But our Asian FoFs are in general among the better performing funds. They have not experienced any J-curve despite the financial crisis.
Also, we are in the seventh year with our first Asian FoFs. It’s still too early to predict what the final outcome will be.
Q: What would you consider as an average return and a good return?
A: You have to look at where you are in the cycle. But my expectation is always that private equity funds should generate 500 basis points (5%) above public market returns.
When you look into Preqin, Adveq is among the better performers. We have always generated that significant risk premium throughout all cycles.
Again according to Preqin, close to 90% of our FoFs’ (net) returns are in the upper or top quartile of the single fund manager universe. That means we have generated equal or higher returns for our investors as if they have invested in single fund managers, but with much broader diversification and lower total risk.
Q: Lastly, what’s your view on the exit markets going forward? How optimistic are you about the M&A market as an alternative exit route?
A: In Western markets, about 80% of all exits are through M&A transaction. In China, it’s about 20%. That number will certainly increase as many potential acquirers are currently reviewing their make or buy strategies.
I believe we will see the first dramatic and necessary shake-up of the Chinese private equity space (over the next few years). Not all investments of the past will find a reception in this volatile and exit-constrained market. It’s a healthy environment to commit now.
About Bruno Raschle:
Bruno Raschle is chairman and founder of US$5 billion-under-management global fund of funds manager, Adveq. Before founding Adveq in 1997, Raschle was the founder and managing director of the MC Partners fund of funds investment programs at Motor Columbus, Switzerland. Raschle holds degrees from the Swiss Federal Institute of Technology (ETH) and Stanford University.