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In this episode of China Money Podcast, guest Chenggang Jerry Wu, principal investment officer of IFC's (International Finance Corporation) climate change fund, discusses IFC's commitment to Chinese private equity funds in the climate change sector, the new opportunities arising from China's pollution treatment efforts, and what he looks for in a first-time fund manager.

Listen to the full interview in the audio podcast, watch an abbreviated video version, or read an excerpt.

Q: Can you first give us a brief introduction of IFC's climate change fund and your role in managing the fund?

A: IFC is the largest multilateral organization focused on emerging markets' private sectors. We invest more than $10 billion a year into private sectors across emerging markets. We started investing in private equity funds in 2000, and have invested in more than 130 funds in emerging markets. I believe IFC invested in roughly 10% of all the private equity funds ever existed in emerging markets. We currently have an active portfolio of more than $2 billion.

Clean tech and energy efficiency is one of our focuses in our private equity investments. IFC started investing in these areas in 2007. Up until now, we have invested in 17 funds in total, and on average we invest in three to four funds per year. The main focus includes traditional clean tech, renewable energy (both upstream manufacturing and downstream power generation), and all sorts of resource efficiency and environmental services (such as recycling, water efficiency, sustainable agriculture and sustainable forestry).

IFC has a subsidiary called IFC Asset Management Co., which is a fund manager that leverages IFC's own expertise and resources with the capacity to raise funds from third party investors. IFC Asset Management Co. set up a Fund of Funds (officially called the Climate Catalyst Fund), which just had its first closing of $500 million, to invest in climate change funds. IFC put $75 million into it, and it will do further fundraising in the future.

I'm not directly managing that FoF. I started in the current position in 2011, and my role is to provide pipeline and resources of the IFC to the FoF, so that they can decide whether to co-invest with IFC or not. I also manage IFC's own investments in the climate change area.

Q: On IFC's website, it describes the IFC Climate Catalyst Fund as part of IFC's strategic focus on addressing climate change across emerging markets. Specially in China, what investments have you made?

A: Given our investment focus, you can probably guess that China is the largest focus of the fund's portfolio. Up until now, roughly 30% to 40% of the fund's portfolio is focused on China. Our focus includes environmental services, waste recycling, renewable energy and energy efficiency. We have also invested in funds investing in water efficiency, water recycling and water treatment.

As you may know, the clean tech and renewable energy sector in China has gone through tremendous adjustments during the past two years. The issue of overcapacity, the European debt crisis and changes in subsidy schemes in Europe have negatively impacted China's export-oriented clean tech sector, especially the solar sector, and to a less extent, the wind sector. A large number of Chinese companies will not survive. But I believe we are at the end of the adjustment, and in fact, it may be a good time to get into the sector again.

Moreover, given the recent headlines about China's (grave) pollution situation, we see this area as having great potential. The new leadership will take pollution treatment seriously.

Q: Do you invest only in private equity funds, or individual projects, or both?

A: IFC does both. For myself, I invest only in private equity funds. We prefer to avoid venture capital funds because intellectual property rights are often at the risk of compromise in emerging markets. For most funds that we invest in, we also have co-investment options with the managers. Of course, IFC has its own direct investment programs into clean tech as well.

Q: There are many private equity funds in China with clean tech and climate change as part of their industry focuses. They might also invest in healthcare or consumer. Do you invest in these multi-sector funds?

A: For my own mandate, I only invest in funds focused on clean tech and climate change. Usually, the funds need to invest at least 80% or 70% of their money into the climate change sector.

Q: For funds that you invest in China, what qualities or experience do you look for?

A: IFC has a mandate to support first-time fund managers. More than half of our fund managers are first-time managers when they first came to us. We normally evaluate their track record and their ability to generate pipelines. Some first-time managers don't have a track record, so we check out their past experiences in doing transactions in that particular market.

Secondly, the ability to generate pipeline is probably the most important aspect. Sometimes in China, people come to us with a long list of pipelines. We dig deep to find out the source of those pipelines, whether they are proprietary or just something the managers heard in the market. In China, to generate pipelines means that you have to have very good local connections.

Q: Can you give us some examples of your investments in China where your investments have positively impacted climate change?

A: We invested in Tsing Capital, which currently manages five funds in the clean tech sector. We invested in two of their funds. They are one of the leading funds focusing on environment and clean tech sector in China. They are a leading institution adopting sustainable investment approach. When IFC invested with them, we worked with them to ensure that they are not only themselves adopting IFC's environmental and social performance standards, but also they ask their investee companies to adopt those best practices as well. On top of that, they also provided very good financial returns to us.

Another example is one from IFC's direct investment program. IFC has worked with many banks in China. We provide them funding and technical assistance to support their clients for small scale energy efficiency projects. It is called China Utility based Energy Efficiency program (CHUEE). We estimate that the projects supported by this program have achieved more than 15 million tons of CO2 emission reduction since the program's beginning in 2005.

Q: What challenges do you face in those funds that you invested in China?

A: All the funds that we have invested currently face the same challenges that are testing other private equity funds in China. We have funds that have a hard time raising additional money, even with IFC support. Also, the exit channel remains challenging for some of our funds.

Q: How do you evaluate your investment performance? Is it just the numbers or you also incorporate impact on climate change?

A: For private equity funds focused on climate change, we ask them to report information regarding underlying projects' environmental impact, such as green house gas emission reduction or clean energy generated. We also collect other social aspects of the funds, such as ratios of female employment and how many small and medium enterprises they support.

Q: Do you have an internal performance target?

A: In general, for private equity funds, 20% is a good number to target. IFC has actually outperformed this for the past ten years. For clean tech, however, we are more conservative given that there are a lot of infrastructure type of investments on the renewable energy side, which traditionally provides stable but lower returns (around mid-teens). Of course, in clean tech ventures and environmental services, you basically are looking at 20% to 25% IRR (Internal Rate of Return), and the performance frequently came out around high-teens to 20%.

Q: Lastly, what's your outlook for your mandate and investments going forward?

A: IFC's investment in climate change funds is relatively small. We invest in three to five funds for roughly $70 million to $125 million on our own book per year. Now with the FoF, we essentially have two sources of money to invest starting from this year, probably doubling the amount of money we can invest. But we won't increase the number of funds we invest. Based on our mapping of the industry, there are maybe 150 or less funds focused on clean tech and climate change across emerging markets. Perhaps we will invest 30% of a fund now with our FoF, instead of 15%.

    Our Guest Today:
    Chenggang Jerry WuChenggang Jerry Wu is principal investment officer at the Private Equity Funds Group of the IFC, responsible for IFC's investments in private equity funds focusing on climate change and resource efficiency. Mr. Wu joined IFC in 1999 as a structured finance specialist. From 2003 to 2008, Jerry worked in the IFC's Global Financial Markets Department, then from 2008 to 2011, Mr. Wu was based in Hong Kong, responsible for scaling up IFC's partnership with local financial institutions to support energy efficiency, renewable energy, water efficiency financing and other climate change related business.

Chenggang Jerry Wu: Shakedown In China's Clean Tech Sector Near End, May Be A Good Time To Invest

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In this episode of China Money Podcast, guest Paul Gillis, professor of accounting at the Guanghua School of Management at Peking University in Beijing, discusses Caterpillar's $580 million write-down in its acquisition of Zhengzhou Siwei. Prof. Gillis explains the three most common accounting tactics Chinese companies use to cheat and defraud foreign investors, and what can foreign investors do to prevent themselves from being duped.

Listen to the full interview in the audio podcast, or read an excerpt.

Q: Caterpillar is taking a $580 million write-down on its acquisition of Chinese mining company, Zhengzhou Siwei, after discovering a "deliberate, multi-year, coordinated accounting misconduct."

Key background: 1, What Caterpillar bought for roughly $700 million was Hong Kong-listed ERA Mining Machinery, which is a shell company that owns Zhengzhou Siwei, a Henan province-based mining equipment maker. 2, Zhengzhou Siwei was absorbed by ERA through a reverse merger in 2010 and never went through a formal IPO process.

So Paul, can you use your imagination, and picture what you think happened when Caterpillar's CFO told the CEO about this massive loss in their C-suit?

A: I imagine that was a pretty awkward situation. It's very embarrassing for anyone at Caterpillar to be involved in a deal like this. I'm sure there is a search for the guilty parties on the way.

Q: Here is what Caterpillar disclosed about how they found out about the accounting misconduct:

"Caterpillar first became concerned about…discrepancies…in November 2012 between the inventory recorded in Siwei’s accounting records and the company's actual physical inventory…Caterpillar promptly launched a comprehensive review and investigation (that) identified inappropriate accounting practices involving improper cost allocation that resulted in overstated profit. The review further identified improper revenue recognition practices involving early and, at times unsupported, revenue recognition."

From the above statement, what accounting fraud can you infer that Siwei has done?

A: The first thing they pointed to are problems with inventory. After counting the inventory in Siwei's factories, Caterpillar discovered Siwei didn't have as much inventory as recorded on their books. That means Siwei was capitalizing these costs and carrying it as inventory costs, as supposed to expensing it in the current period, which could lead to their profits significantly lower.

The more serious allegations in my mind are revenues being recognized too early or inappropriately. So some sales were recorded before they were actually completed. But this is a very common practice in China.

Western accounting standards are very detailed about when you can recognize revenue. For example, you must have signed contracts; you can't have rights of return; or obligations to do more things in the future. But in China, businesses are done more on relationships. The contracts are less important than the handshake. So I would not be surprised if management at Siwei didn't think they were involved in any kind of fraud relating to revenue recognition.

Q: But it does sound like that Caterpillar didn't check out Siwei's books and didn't examine physical inventories. Do you think it's likely?

A: It's hard to know. Caterpillar did say that they hired two Big Four accounting firms: Ernest & Young and Deloitte Touche Tohmatsu. It is unusual to hire two Big Four firms. But the due diligence is a customized process. Did the accounting firms miss what were right there in their face? Or did Caterpillar tell them not to look at certain things? We don't know.

The other thing is that you need to have access to get to the records and the people to conduct due diligence. But in some situations, you might not get as much as you'd like.

Q: One obvious red flag here seemed to be the fact that Siwei become part of ERA through a reverse merger. Wouldn't that already alarm auditors and buyers?

A: Everyone should have learned lessons on reverse mergers. The lack of scrutiny of reverse mergers deals is very dangerous. The number of accounting fraud associated with reverse mergers is huge. Most are U.S.-listed Chinese companies. Caterpillar is the first case involving a multinational strategic buyer and a Hong Kong-listed Chinese company through reverse merger.

The U.S. stock exchanges have effectively stopped reverse mergers by new rules that require reverse merger targets to be "seasoned" before listing. Hong Kong and other markets should probably look at potentially implementing the same rule.

Q: Who are legally liable relating to Caterpillar's massive losses?

A: Let me first give some clarifications about this goodwill write-down. Caterpillar paid significantly more than Siwei's book value. That excess was put into goodwill. Every year, a company has to determine whether it can continue to justify carrying that goodwill balance on the balance sheet. In this case, after learning all the accounting practices at Siwei, Caterpillar decided that Siwei will not be as profitable in the future as originally anticipated. What this means is essentially Caterpillar paid too much for Siwei.

When you pay too much for a company, who's at fault? Clearly, there will be a lot of focus on the management of Siwei. I understand that some of the purchase price is to be paid in notes. Surely Caterpillar's lawyers are looking at whether or not to pay those additional balances. The auditors of Caterpillar and the accounting firms that did the due diligence will also be looked at. Lastly, shareholders will also look at the management and board of Caterpillar. I think a lot of questions will be answered in the next couple of years.

Q: Do you expect anyone will be arrested and face criminal charges?

A: Not in China. I'm not aware of any criminal charges on an accounting fraud in China. Chinese government does not seem to consider accounting frauds as crimes in China.

Q: Looking at the broader Chinese accounting landscape, what are some of the most commonly used tactics by Chinese companies to cheat investors?

A: The most common is probably inappropriate revenue recognition or fake revenue. That's the simplest way to increase profits.

Relating to that are ways to fake cash balances. Once you record a sale, you need to find some place for it on the asset of the balance sheet. If you put it on receivables, the auditors will ask troublesome questions. So many companies record fake cash and convince banks to lie to auditors.

For example, a Chinese company created a fake online banking website to cheat auditors last year. The auditors found that an interest rate on the bank statement did not match Chinese Central Bank's official rates. The company promptly replied that it was a bank error and it was fixed in half an hour. The auditors became suspicious and clicked on some other buttons of the website, and found out the whole website is a fake.

Another example is putting deposits with contract manufacturers. If you use contract manufacturers, you usually have to give them some funds up front. That's a very hard number to audit. In some cases last year, auditors have decided to resign after determining that they can't verify those numbers.

A third tactic is the use of Variable Interest Entity (VIE) structure. It's been prone to accounting fraud (in a similar way like reverse merger).

Q: Lastly, what should overseas investors do to prevent a repeat of Caterpillar's sad fate?

A: If a foreign company is buying a Chinese company, it needs to go through a due diligence process that is significantly more vigorous than usual. It really needs to get access to all the records and people, and follow forensic auditing procedures that are intended to root out fraud. That means paying a lot more fees. Too often, these audits go to the lowest bidder, and that's just not appropriate.

Also too often, management of the company is trying to find ways to get the deal done. But when you do a deal in China, you really have to use another perspective. Look for reasons to not do the deal. Not for reasons to do the deal. Because China is an extremely high risk environment.

    About Paul Gillis:
    Paul GillisPaul Gillis is professor of accounting at the Guanghua School of Management, Peking University in Beijing, China. Gillis is a member of the Public Company Accounting Oversight Board (PCAOB)'s Standing Advisory Group. PCAOB is a nonprofit corporation established by the U.S. Congress to oversee the audits of public companies. Gillis also authors China Accounting Blog.

Paul Gillis: Three Accounting Frauds Most Chinese Companies Use To Cheat Foreign Investors

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In this special Chinese New Year's edition of China Money Podcast, we look at the fortunes of the Chinese stock market and various zodiac signs in the year of Black Water Snake, 2013.

Asian brokerage firm CLSA Asia-Pacific Markets released its Feng Shui Index in 2013. The tongue-in-cheek index points to a strong first half for the Hang Seng Index during the first half of 2013, with the second half dominated by volatile movements in both directions. The whole year, however, will end up higher.

CLSA says the past five Snake years – back to the Water Snake of 1953 – are not encouraging. Snake years are marked by major transformation and change, including Pearl Harbour (1941), Twin Towers (2001), Tiananmen (1989), Fall of the Berlin Wall (1989), Great Depression (1929), recessions (1953, 2001), revolutions (1917, 1989) and major conflicts (1941, 1965).

In terms of sectors, CLSA expects the best performances from those traditionally associated with Metal (the likes of broking and financials) and also Water (such as gaming and logistics).

If you are a Roosters, Cows and Dogs, fortune will be outstanding this year. But Pigs, Tigers, Sheep and Snakes would need to work hard to improve their luck.

Happy Chinese New Year to all of our listeners and subscribers. 

Feng Shui For Heng Seng Index And Chinese Markets Points To A Mixed Bag In 2013

本期的中国金融播客，标准普尔企业评级董事符蓓对2013年中国房地产市场的走势，销量，融资市场进行分析和预测。

请收听完整的音频采访，或者阅读下面的文字采访摘要。

2013年中国住宅房地产市场是否会重回复苏轨道？

今天，我们标准普尔发布的报告是将中国房地产行业的展望从负面转到了稳定。这基于三个主要原因（我们跟踪和分析的是中国房地产市场比较大的三四十家上市公司）。 一是自去年第二季度以来截至到今年以来，地产商销售的态势呈现一个畅旺的趋势。特别是今年一月，我们看到标普评级公司的销售是非常强劲的。第二是中资房地产开发商的融资渠道是比较畅通的，融资成本也呈现下降的趋势。 许多公司在财务管理方面和扩张策略上越来越务实，有一定的纪律性。

此次展望的上调意味着今年标普相比于过去一年半来讲不会有那么多的负面调整，甚至会有一些正面调整。当然，这些是对我们分析的大的房地产公司而讲。对于中小型公司今年的情况可能与之不同。

今年房地产销售与宏观政策的展望

我们有评级的约30家房地产公司在2012年销售非常强劲，大部分公司超过了其年初预定的目标，整个30家公司平均超过12％。整体去年相比2011年的增幅也是非常强劲的，整个30家公司录得23％的增幅。个别公司，如世贸，都有超过50％的增幅。

今年，我们认为不一定增幅会如此大，因为去年的基数已经变大。但我们认为销售还是会有一个不错的表现。这是基于我们对宏观政策的解读。我们觉得今年虽然会根据市场的变化会不断的有微调，但整体政策不会有大幅的放松或收紧。

今年融资方面的预测

特别是海外融资，今年一月份我们看到中资地产商有发债和配股行为。有些公司今年融资不仅金额比较大，而且融资成本比起以往特别低，如龙湖，合景泰富，其利率从过去的13％下降到8％左右。我们预测今年国内的融资渠道与去年是差不多的，应该不至于回到2011年那种从紧的状态。

我们认为地产商的财务纪律性是非常重要的。早在2009年行业复苏阶段，许多地产商很激进的扩张态势。今年我们观察到很多地产商比较有节制，在拿地和债务扩张方面都比较谨慎。很多公司发债或者配股后一部分或者全部资金都是去做再融资，而不是新增债务。基于以上原因，我们认为房地产行业今年负面压力较小，整体将出现稳定的状态。

本期嘉宾：
符蓓是美国评级公司标准普尔的企业评级董事。她主要负责房地产市场的分析与评级。

符蓓：中国房地产市场2013年无牛市，将保持平稳

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In this episode of China Money Podcast, S&P analyst Bei Fu discusses the outlook for China's property sector, potential policy moves and property sales predictions. She made the following comments during a teleconference call held by Standard & Poors.

Listen to the full interview in the audio podcast, or read an summary below.

Will China's property market return to the path of recovery this year?

S&P released a report today to upgrade the outlook for the Chinese property sector from negative to stable. This is in consideration of the following three phenomena that we have observed from the thirty or so large listed Chinese property firms that we cover.

Number one, property sales have been robust since the second quarter of last year. In January 2013 in particular, we have seen those firms posting very strong sales. Two, the funding channels for Chinese property developers have been favorable, and funding costs appear to be lowering. Lastly, many companies have shown discipline in terms of expansion and financial management.

Our upgrade today meant that in 2013, S&P won't have as many negative rating actions as we did last year. We will even possibly have some rating upgrades this year. Of course, these are the large listed developers that we cover. For small-and-medium sized developers, their situations might not be so smooth.

Outlook for property sales and policy

In 2012, the roughly thirty developers that we rate have posted strong sales. Most companies exceeded their annual target, and on average, sales were 12% over target. Compared to 2011 levels, on the whole, sales were up 23%. Some companies even realized growth of 50%.

This year, however, we don't think growth will be as strong as last year, partially because 2012 is now a higher base to compare with. Though we still believe sales will be reasonable this year as the policy environment won't worsen. We believe the government will fine-tune policy according to market developments, but won't have any significant loosening or tightening.

Predication for Chinese property developers' funding environment

In January, we've seen some Chinese property developers issuing debt. Some companies not only raised large amount of money, but also achieved low interest rates. We've seen rates on bond issuance drop from 13% to 8%. We predict the funding environment for Chinese developers will be similar to last year's, but it won't go back to the tight environment we saw in 2011.

Many developers exhibited financial discipline that we didn't see during 2009 when the industry was recovering. This year, we have seen developers being very careful in expansion and debt issuance. Many companies used the proceeds from their debt issuance for refinancing, rather than acquiring new land or adding on new debt.

Overall, we see the Chinese property sector under less pressure and staying steady this year.

    Our Guest Today:
    Bei FuBei Fu is a Hong Kong-based analyst at American rating firm, Standard & Poors. She is responsible for the analysis and rating of the Chinese property sector and its developers.

Bei Fu: China's Property Sector Will Stay Steady In 2013

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In this episode of China Money Podcast, chairman of global markets, China at J.P. Morgan, Jing Ulrich shares her thoughts on where China's economic recovery is headed next, what policies the government is likely to take to contain potential property sector overheating, and if Chinese state-owned enterprises will contribute more to help build up China's social welfare systems.

She made the comments during a press briefing held by the Foreign Correspondents' Club Of China (FCCC) in Beijing on Monday, Feburary 25, 2013. Listen to the full interview in the audio podcast, or read a summary below.

On China's economic recovery and its key drivers:

We've certainly had a rebound since late November (last year). The recovery has been underway for a good three months now. It's important to keep in mind why we've had this recovery. I think the key reason is a significant increase in liquidity. There has been so much money pumped into the economy during the past several months. In January, aggregate social financing went to an all-time high of 2.54 trillion RMB. Total bank lending also surged to over 1 trillion RMB, meaning bank lending has become less important to the overall liquidity picture in China. But now three months into the recovery, we already have some concerns about overheating.

On potential overheating of the Chinese property sector:

It's becoming more apparent that the property market is running into potential overheating territory (as indicated by price increases, transaction volumes and aggressive expansions by property developers). Sometime over the next few months, we could have some government measures to restrict the increase of property prices.

One, restriction policies on home purchases will be more strictly implemented. Those measures were never removed, but the implementation became a bit more relaxed since mid-2012. Secondly, other cities (currently with no purchase restrictions) could be subject to the same tightening rules if their property prices are seen as rising too fast. Then, on the financing side, especially for second or third mortgages, the cost and availability of financing will also become more hostile to home buyers. Lastly, recurring property tax will be rolled out to a larger number of cities from just Shanghai or Chongqing today.

On how China's infrastructure investment will evolve in the future:

In the last ten to fifteen years, China's infrastructure investment was focused on supporting its export-manufacturing sector. In the next ten years, infrastructure investment will shift to support Chinese people's livelihood, such as urban subways, light rail and environmental improvement. The amount of money the government will spend on these will be still humongous.

On if China's state-owned enterprises will pay more dividend to support China's social welfare build-up:

There is an unspoken rule that state-owned companies listed on the domestic A-share market should pay 30% or 40% of their profits in the form of dividends. The listed companies pay dividends to their parent company. The parent company is owned by the State-owned Assets Supervision and Administration Commission (SASAC), which is under the State Council.

Take China Mobile for an example. China Mobile Hong Kong (CMHK) pays dividend to its parent company, China Mobile Holdings. Other shareholders also get the same dividend. China Mobile Holdings pays the money to SASAC. SASAC reallocates those dividends from companies that are successful to companies that perhaps need cash. Some cyclical industries, such as aluminum smelting or shipping, are loss-making right now. So there is some reallocation of resources among the SOEs. But I think it's a fare assumption that China will expect the large SOEs to contribute more to the broad social welfare agenda. But for now, the Central Government has plenty of money. So it doesn't really need the dividend.

In addition, when a state-owned enterprise does a public listing overseas, 10% of proceeds goes to the National Social Security Fund. That is supporting China's overall pension system, although the NSSF is a fund of last resort. It doesn't pay out anything right now, but eventually, that money should benefit China's retirees.

    About Jing Ulrich:
    Jing UlrichJing Ulrich is chairman of global markets, China at J.P. Morgan. She is responsible for covering the firm's most senior global clients across all asset classes and for maintaining relationships with executives of China's leading enterprises and government entities. Previously, Ulrich was managing director of Greater China equities at Deutsche Bank. She also spent eight years at Credit Lyonnais Securities Asia, where she led the top-ranked team covering China.

Jing Ulrich: China's Infrastructure Boom Will Continue With A New Theme

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In this episode of China Money Podcast, founder and CEO of Palico, Antoine Dréan, shares what he sees the fundraising environment will be for China-focused private equity funds this year, and why secondary transactions of Chinese private equity fund stakes among Limited Partners (LPs) will likely double in 2013.

Listen to the full interview in the audio podcast, or read an interview excerpt below.

Q: First, give us a brief introduction of Palico and Triago, two companies you founded and currently hold positions in?

A: I started Triago over twenty years ago. The objective back then was to help private equity fund managers in Europe to raise money from limited partners (LPs) in the U.S. Triago, (as a placement agent), has grown to be one of the market leaders in both fundraising and secondary transfers (meaning we help LPs sell their stakes in private equity funds to other LPs). I am still chairman of Triago, but am no longer involved in the daily operations.

I am now very involved in the daily operations of Palico, which is an online "dating service" for private equity GPs (general partners), LPs and service providers such as placement agents or lawyers. We will soon reach 1,000 members from 60 different countries with many blue-chip LPs and GPs.

Q: What has Palico achieved in attracting China-focused private equity GPs and LPs?

A: Actually, fund managers and investors based in China account for about 14% of our membership base. That is a much higher percentage point compared to their weighting in total fund number and asset-under-management globally. We estimate China represents about 6% of the $3 trillion asset-under-management out there globally.

Q: In 2012, the volume of China-focused private equity fundraising has dropped by 50%, mostly due to the decline of RMB fundraising, but USD fundraising also suffered. How have LPs changed their mindset about allocating to Chinese private equity funds?

A: According to Palico's own database, fundraising (both RMB and USD fundraising) in China has dropped about one third last year from 2011's all-time high. So the severity of the decline depends on which source you look at. Though a one-third drop is still high, at about $11 billion in total funds raised, 2012 still represents the third best year ever for China fundraising, following 2011 and 2008.

Considering growing interests among our LP members and what will be available for global fundraising as private equity "dry powder" (see explanation below) expires, we expect at least the same amount (of last year's fundraising total) will be raised for China funds this year.

We estimate there is $100 billion of "dry powder" in Chinese funds, meaning money that GPs haven't invested and that they can still draw down from their investors. This is one eighth of the global private equity "dry powder" of $800 billion. We feel China should take a greater share of global fundraising in coming years as the Chinese economy recovers. Those well structured USD and RMB denominated China funds with good track records will continue to raise funds with ease in 2013.

Q: What do you think will happen to that $100 billion "dry powder" in China this year?

A: You have two groups of GPs out there. Those with good deal flow and discipline, they will be able to put money at work in good terms. Those with poor deal flow and less discipline, they will probably either use the money in the wrong way, or they will have to leave the market at some point. We estimate that at least 50% of this "dry powder" could vanish in the next couple of years if the market condition doesn't change.

We feel the Chinese private equity market will rationalize. Out of the 1,000 or so GPs in China, close to a quarter will fail to raise a new fund in the years to come.

Q: Does this mean the number of private equity funds in China will decrease?

A: Probably not. When a group of managers disappears, you probably have at least one spin-off, or sometimes two. So the overall number could increase. I think the Chinese private equity business will only grow, and we are just at the beginning of this growth, both in asset-under-management and total number of firms.

Q: For GPs in China and other emerging markets wanting to raise a new fund this year, what do you think the fundraising environment will be?

A: Private equity is still an interesting asset class to investors as it is one of a few places where returns can get returns in the two-digit range. The issue is exits.

The amount of money that's still "trapped" in private equity portfolios is staggering. Over the last forty years, $3.8 trillion were raised for private equity funds globally. But if you look at the four bubble years from 2005 to 2008, close to 50% (or $1.8 trillion) were raised during this period. Only 22% of this money has been returned to investors.

Since most LPs invested "big" in this past cycle and they are still waiting for their money to be returned, it means they are over-allocated to private equity. So even if LPs love private equity, they will have to wait a bit for exits to happen before they can recommit.

There is one exception. LPs who trade on the secondary market (meaning buying and selling of private equity fund stakes among LPs) have more flexibility. Ten or fifteen years ago, the secondary market was tiny with a small number of sellers, usually distressed institutions, and professional secondary funds who specialize in buying private equity fund stakes from LPs. There were about 30 players doing a few deals each year.

Today, there are 500 to 600 buyers including specialized secondary funds, fund of funds, family offices, etc. Last year, there were about $25 billion of secondary transactions. Ten years ago, the volume was $2 billion. So if you are a seller today, you can get a decent price for your private equity fund stake, around par at this point.

The reason for this growth is not only the difficulties in exits on the GP level, but also because LPs are more willing to manage their private equity allocation. They may want to sell some underperforming stakes and buy more stakes that they think will perform well in the future. We estimate the secondary market will grow to at least 5% of the total asset-under-management of $3 trillion, or $150 billion, in the next five or more years. And we think the IPO backlog will boost China-focused fund secondary deals to about 8% of this market in 2013 from around 4% last year.

Q: What will be the impact from this increased trading of private equity fund stakes among LPs?

A: Performance at the GP level won't be impacted. As to the LPs, it depends on if they sell their stakes at par or take a haircut.

Q: You are also predicting growing secondary transactions of portfolio companies among GPs in China? What kind of growth do you see?

A: The fact that a private equity fund is selling a portfolio company to another fund is a sign of maturity. It shouldn't grow too much, otherwise it could look like artificial sales.

If this type of secondary transactions takes about 30% to 40% of total deals, the market is okay with it. In Europe and the U.S., when secondary buyout deal takes up to 70% of total deal numbers, people were fearing bad times because it means fund managers have difficulty exiting their investment outside of their peers.

    About Antoine Dréan:
    Antoine DreanAntoine Dréan is founder and CEO of Palico, an online marketplace for the global private equity fund community. In 1992, he founded Triago, Europe's first independent private equity placement agent. In 2007, Antoine founded Mantra, an investment company focused on listed private equity and non-traditional private equity funds. Antoine holds an MBA from the Wharton School of the University of Pennsylvania, and is a member of the Wharton Executive Board for Europe, Middle East, and Africa.

Antoine Dréan: Secondary Transactions Of Chinese PE Fund Stakes Among LPs Will Double In 2013

Visit http://www.chinamoneypodcast.com for more great interviews! 

In this episode of China Money Podcast, Dalton Investments' Shanghai-based portfolio manager, Tony Hsu, explains how to execute the playbook of Warren Buffett in China, the reasons why Dalton's Asian equity strategy has consistently beat the market and his outlook for the markets in 2013.

Listen to the full interview in the audio podcast, watch an abbreviated video version, or read an excerpt below.

Q: First, give us a brief introduction of Dalton Investments and Dalton's Asian equity strategy?

A: Dalton Investments was founded on the opportunities that arose from the Asia Financial Crisis in the late 1990s. Dalton is a value-oriented investment management firm with a focus on capital preservation and long-term growth. Today, we manage about $2 billion in separate accounts in hedge fund strategies for a number of pension funds, endowments, foundations and family offices.

Our main strategies include global equities, Asian equities, distressed debt and distressed mortgages. About 50% of our total assets are in Asian equities. We run a Dalton Asia Hedged Strategy, which was launched in the beginning of 2008. Since the inception, the Dalton Asia Hedged Strategy is up nearly 50% while the MSCI Asia Index is down nearly 20%. As of the end of this February, the strategy is up over 6% while the MSCI Asia Index is up 4%.

Q: Your Asian strategy uses long-short tactics. What kinds of stocks do you normally short?

A: From the long side, we want to invest in entrepreneur-led undervalued companies. On the short side, it is exactly the opposite. Our short book is mostly filled with state-owned enterprises (SOEs) where senior executives tend to be former politicians or state appointees.

One of our current short positions is a state-owned oil and gas exploration company in Thailand. The company was pressured by the government to expand aggressively overseas and has made a series of over-priced acquisitions in Canada and Africa. Since 2010, their intangible assets have grown 20 times. We believe if the goodwill gets written down – and we think it will – it will hurt the share price.

Q: Within the Asian equities market universe, how attractive do you find the H-share market right now?

A: We generally invest in the H-share market and do not invest in the A-share market. There are far more entrepreneur-led companies listed in Hong Kong that are focused on increasing shareholder value, while the Shanghai (Stock Exchange) is filled with SOEs. Currently, we are running about a 30% net long exposure in China through Hong Kong listed stocks.

Q: Among your China-themed investments, do you favor any particularly industry?

A: We don't. We do, however, favor those family holding companies that are trading at a large discount to Net Asset Value (NAV).

Family-led and entrepreneur-led companies in Hong Kong tend to have a pyramid structure. The holding companies at the top own controlling stakes in the groups of operating companies below. The families or entrepreneurs have a lot of their personal wealth tied to the holding company. We want to be as close as possible to the top of the pyramid.

Also, many operating companies trade at a discount to their intrinsic value. So, if you are buying the holding company at a discount, and each of the subsidiaries trade at a discount, you are getting a discount upon discount by investing at the top of the pyramid.

Q: What are some other valuation metrics you look at?

A: We look at many other metrics such as price-to-book and EV (enterprise value)-to-EBITDA (earnings before interest, taxes, depreciation and amortization) on a regular basis.

Q: Surely, your due diligence process goes beyond the computer screen?

A: Absolutely. Investors have to be careful in emerging markets such as China as managements are not always shareholder friendly. We try to mitigate this risk by investing in companies that are run by entrepreneurs with significant skin in the game. Also, we favor companies that are run by second or third generation entrepreneurs who have experienced previous downturns.

Moreover, our process involves research on the executives themselves, including understanding the family background and whether they have large outside interests. We want to make sure the family's wealth is tied to the publicly listed entity. If they have a lot of outside interests and each entity is doing business with each other, then investors are susceptible to transfer pricing and other risks surrounding corporate governance.

Q: How many stocks do you usually hold in your portfolio? Do you have a more concentrated portfolio or you tend to focus more on diversification?

A: For our Dalton Asia Hedged Strategy, we usually hold between 60 to 90 companies counting both long and short positions. The size of each position is typically between 2% to 5% of Net Asset Value (NAV) of the Dalton Asia Hedged Strategy.

In North America, you can make a value strategy work by investing in cheap companies (alone) because internal and external pressures will eventually make the company change (and its stock prices converge with its intrinsic value). But in Asia, those pressures don't exist. So we try to promote management actions to increase shareholder value through what we call "friendly activism." We write letters to management and meet regularly with the entrepreneurs to encourage (value enhancing) actions such as increasing dividends or share buybacks.

Q: Can you give us an example of your successful investments that has contributed to your returns?

A: One of our best performing investments over the past year is a U.S.-listed Taiwanese company called Himax Technologies, one of the largest producers of LCD display drivers (An LCD display driver is the chip that controls the voltage and timing to move the pixels on a LCD screen). So every LCD screen in the world needs a display driver, and Himax produces a billion display drivers a year.

When we initiated the position in the fall of 2011 the stock had a market capitalization of less than $200 million, and traded at a price-to-book ratio of less than 0.5 times.

Q: Any particular reason why it's trading so low?

A: In late 2010, Himax's largest customer, one of the largest LCD panel makers in the world, decided to diversify its suppler mix. So Himax's sales to them went from nearly 70% of its total sales to 30% in a short period of time. Its share price collapsed, but Himax adapted quickly and was able to increase sales in the fast-growing small panel segment for smart phones and tablets. Since then, Himax’s stock has significantly outperformed the market. We think it still trades at a reasonable valuation given its growth prospects.

Q: Share with us some investment decisions that you regret and the lessons you've learned?

A: A few years ago, we shorted a Chinese state-owned construction company that was extremely overvalued at the time. (After we took our position,) the stock price rallied, and it became a larger position in our portfolio. Moreover, as the share price moved up, we added to our position as we believed the fundamentals of the company were still not right.

In the end, the share price did fall and we made a profit. But initially the stock price shot up for the next three months after we shorted it, and it took about eight to nine months for the share price to collapse.

The lessons learned are that we can't time the market, nor do we try to time the market. We are patient investors and allow time for our thesis to play out.

Q: Lastly, what's your outlook for the H-share market this year?

A: I think overall there will be a lot of volatility, and stock pickers like ourselves will benefit. In 2008, pretty much everybody lost money, and most people made money in 2009. From 2010 onward, we have seen some real alpha being generated by stock pickers. I think 2013 will be the same.

About Tony Hsu:
Tony Hsu is portfolio manager of Dalton Investments, a Los Angeles-headquartered investment management firm with $2 billion in assets under management. Hsu manages Dalton's Asian equities strategies and co-manages Dalton’s Pan-Asia and Greater China portfolios. Prior to joining Dalton, Hsu held positions at Foxconn International Holdings in Shenzhen and at Goldman Sachs. 

Tony Hsu: Invest Like Warren Buffett With A Chinese Twist

Visit http://www.ChinaMoneyPodcast.com for more great interviews!

In this episode of China Money Podcast, head of non-listed real estate Asia in APG, one of the largest pension fund asset managers in the world with assets under management of approximately €325 billion, Daan van Aert, discusses APG's investments in China such as car parks and logistic warehouses, his views on the Chinese residential property market and if distressed properties in China present good opportunities for investors.

Listen to the full-interview in the audio podcast, watch the shortened video version or read an excerpt below.

Q: APG is one of the largest pension fund asset managers in the world with €325 billion under management. Give us some background on AGP's investments in Asia, and what kind of role does Asian real estate play in APG's overall strategy in Asia?

A: APG started an office in Hong Kong in 2007 with a mandate for private equity real estate and infrastructure investments. Shortly after, we expanded our team to include listed real estate equity and emerging market equity. Since we started, our portfolio in Asia has grown from €1 billion to €9 billion under management.

Of the €9 billion assets currently under management, €6 billion is in both listed (€4 billion) and private (€2 billion) real estate. In terms of geographical breakdown, about 70% to 75% of our total real estate portfolio is in developed markets such as Japan, Hong Kong and Australia. The rest is in emerging markets, and China takes about half of this portion.

Q: How much capital are you deploying every year into private real estate?

A: We don't have a target. What we do is to look at our already large existing portfolio and focus on strategies and the right partners to add value. If we can find interesting strategies and strong partners, then we will invest more money.

During the last few years, we have been investing considerable amount of money continuously. Our real estate portfolio has grown from €1 billion in 2007 to €6 billion, from both investment appreciation and new allocations. That gives you a sense of our growth.

Q: What is the average size of your investments and how many investments do you usually keep in your portfolio?

A: We serve very large institutional clients, therefore we won't look at transactions under $75 million. In terms of the number of investments we have, we don't really have any preferences, as our global real estate portfolio is already very diversified.

Q: Among some major categories of real estate: residential, retail, office buildings, logistics, which segment(s) do you find the most attractive in China right now?

A: We think logistic warehouses are the most attractive sector. China's strong growth – not only in imports and exports, but also in domestic consumption – is leading to enormous amount of flow of goods. The need for quality logistic warehousing is gigantic. In addition, the amount of capital spending for developing logistic warehouses is less compared with office buildings and retail properties, for example.

The challenge is that it's difficult to buy land to develop logistic warehouses, as the land sales and tax revenues are less attractive to local governments. We have already invested in a logistic property in Shanghai, and we think there is still room to increase our investments in this category.

Q: You've invested in Australian logistics properties, Indian hotels and car parks in China. Are there any sectors that you would avoid in China now?

A: In general, we are less interested in the office sector because of its cyclical nature. In China, you usually cannot buy and hold a whole office building because lots of transactions are what we call "strata title sales," where the developers are selling the building floor by floor. This makes it harder to buy and manage a whole building, and creates difficulties later on when you want to sell.

We are interested in the residential housing market in China because we believe there is still ample demand for quality housing. The government's new tightening measures are also healthy for the market's long-term prospects.

Q: Are you finding lots of opportunities in the distressed property market in China now?

A: There are some distressed opportunities, but not on a large scale. Sometimes you see certain developers needing more capital, but not on a scale that we have found attractive opportunities.

Q: Can you share with us your investment decision-making process?

A: We first look at country dynamics, such as political environment, financial stability, growth prospects, inflation, etc. Then we examine the real estate industry dynamics, including the depth of the market, legal framework, government policy, regulatory environment, etc.

Afterward, we zoom in on the specific real estate opportunity. We look at strategy, partners, structures of the transaction, corporate governance, tax structures, etc.

We receive advice both internally on legal and tax issues, and externally on valuation, sustainability, control risks systems, and so on. So we have a very vigorous and thorough due diligence process.

Q: APG committed $150 million for the first close of a fund with China Overseas Land & Investment and ICBC International Holdings last February. How is that investment developing?

A: We have started several projects in different cities, and they are going well.

To emphasize, we are strategic financial investors. We don't have teams based in China, though we have people with deep experience in the Chinese markets. So we need strong local partners like China Overseas Land & Investment and ICBC International to be on the ground to source the best projects. But of course, we are very engaged on the strategic direction of our investments, and work closely with our partners, whose interests are closely aligned with ours.

Q: What's your target return?

A: We look at each investment's risk profile and assess a target performance case by case. The target returns vary, from high single digits for core products to high double digits for very opportunistic strategies.

Q: Going forward, what's your outlook for APG's investments in Asia and China?

A: We definitely see our investments growing. We see growing demand for high quality real estate in the emerging markets, and we can fill the gap as a capital provider. Currently, 24% of our global real estate portfolio is in Asia. I certainly see that ratio growing over time.

Q: Can you share some of your investment mistakes and also the lessons you've learned?

A: Since the global finance crisis, we are more cautious about using leverage. We started to refocus on the real estate fundamentals, rather than using leverage to drive returns.

Now, our target globally is to have leverage ratios lower than 40% (loan-to-market value). At this stage, our leverage is around 30% globally and in Asia.

Q: One major challenge of investing in private real estate is illiquidity. What are you doing to mitigate that risk?

A: First of all, we are long-term investors. Secondly, if your investment portfolios are good, selling some stakes is doable right now. We see future growth in the secondary market in private funds, which is a global trend. But if you have very opportunistic strategies where you are developing projects and hoping to sell, it will be more difficult to sell as most of the value is generated at the end of the fund's life span.

    About Daan van Aert:
    Daan van AertDaan van Aert is head of non-listed real estate Asia of APG (Algemene Pensioen Groep NV) in the Netherlands, one of the largest pension fund asset managers in the world with assets under management of approximately €325 billion. Van Aert is responsible for APG’s €2 billion non-listed real estate investments in Asia Pacific.

Daan van Aert: Logistic Warehouses/Car Parks Present Best Property Investment Opportunities In China

visit http://www.ChinaMoneyPodcast.com for more great interviews! 

In this episode of China Money Podcast, founder and CEO of Beijing-headquartered, $500 million-under-management HAO Capital, Simon Eckersley, talks with our host, Nina Xiang, on HAO Capital's investments in the healthcare and environmental protection sectors, the firm's plans for future fundraising, and some key methods it uses to help portfolio companies grow.

Listen to the full-interview in the audio podcast, watch the shortened video version or read an excerpt below.

Q: First, give us a brief introduction of HAO Capital?

A: HAO Capital is a Beijing-based private equity firm. We take minority stakes in growth businesses in China, and focus on healthcare, consumer and light industrial (including clean tech) sectors.

We started raising our first fund in 2005, and closed in 2007 with $100 million. We raised our second fund of $400 million from 2007 to 2008. We've done a number of co-investments worth around $50 million as well, so we currently manage over $500 million.

Q: Going back in history, can you share with us your experience of raising your first fund back in 2005 and 2006?

A: At the time, there was less competition in terms of the number of (China-focused) funds. But then, a lot of LPs (Limited Partners) were also not really focused on China, as it's still a fledgling private equity market. It's different today. Looking at our own LPs, they are invested in (many more) China funds compared to back then.

Q: What is the average size of your investment, and how many active investments do you have now?

A: On average, we look at investments in the $20 million to $50 million range. We currently have 14 active investments between the two funds. The first fund is almost fully paid back. We've exited a lot of the investments from that 2006 and 2007 investment vintage, and are only managing a couple of investments from that fund.

We started investing the second fund in 2008, and is now about 80% invested. We've exited or partially exited a couple of investments, but are still managing most of that portfolio.

Q: And one of the portfolio companies is SKR, a company focused on diagnostic imaging medical equipment. It has a joint venture with Chinese electronics maker, TCL Corp. Can you share with us the latest on this investment?

A: The per capita spending on medical equipment in China is a few dollars compared with hundreds of dollars in the developed countries. It's obvious that China's healthcare market has enormous potential for growth.

But there are actually very few medical equipment companies of any scale in China. There are a lot of small regional companies. Many of them don't have the research capabilities to develop Generation II or Generation III products after launching Generation I products. They also tend to lack management talent.

Today, the high-end medical equipment market in China, such as MIR, PET-CT scan, ultrasound, is really controlled by GE, Philips and Siemens. They take, in certain subcategories, 75% to 100% of the market share. So, we partnered with a group of executives headed by Zhi Chen, former president of GE Healthcare in China, to form SKR. And SKR has a joint venture with well-known Chinese consumer product manufacturer, TCL Corp., to create TCL healthcare whose vision is to enter that high-end medical equipment market and become a national champion.

Several decades ago, GE, Philips and Siemens, all moved from consumer products to healthcare equipment, leveraging their manufacturing capabilities, brand and scale. So from TCL Corp.'s perspective, it is following the trajectories of its Western predecessors.

One of the central themes for this business' growth is through acquisition. That's something we have been focusing on during the past six months. There are a number of opportunities that we are in the process to realize and will give a significant boost to the business.

Q: It sounds very ambitious, and no doubt there will be plenty of challenges that you will encounter. So far, what's the biggest challenge?

A: Sure, these things don't happen overnight. To have a full suite of products will take time. So initially, we will focus on penetrating certain sub segments.

Q: But every private equity fund has a fund life and faces pressure to realize returns. What's your thinking on exits for this investment?

A: The likely exit is probably an IPO, and we are considering other exit possibilities. Sometimes, it takes much longer for a company to achieve their full potential than we are allowed to stay invested. But I believe we will be able to achieve an attractive return within our time frame.

Q: HAO Capital also invested in an interesting company called LP Amina in the environmental protection sector. Can you share with us the progress on this investment?

A: The enormous challenges China faces in managing its environment also present great investment opportunities. LP Amina is one great example. Founded by William Latta, a former executive from Lastom Power, it provides products that improve coal-fired power plants' emissions and efficiency.

In the beginning of last year, China released new nitrogen oxide emission reduction regulations. As a result, revenue increased a couple of hundred percent. The company's backlog at the end of 2012 was almost four times of the total revenue of last year. So it was a breakout year for the company.

Q: Last time when we chatted, you pointed out trade sales, secondary transactions between GPs and share repurchases as alternative exit possibilities, considering the IPO market remains essentially shut. From LPs' perspective, have you heard from any of your LPs discussing selling their China private equity stakes?

A: We know of an LP who pulled out from private equity completely, not just its exposure in China. So we were part of this secondary process. As a result, one of the world's best-known private equity investors took over the position. So it actually worked out quite well for us.

Q: You have plans to raise a third USD fund? And, any plans for raising a RMB fund?

A: Our intention is to go out and raise a third USD fund during the second half of this year. As far as raising a RMB fund, it's something we flirted with several years ago, but ultimately decided to see how the market will evolve. If we were going to raise a RMB fund, it won't be a "me-too" approach. It will be separate from what we do on the dollar side: Either the size or the strategy will be different so that the two don't directly conflict.

    About Simon Eckersley:
    Simon EckersleySimon Eckersley is a co-founder and CEO of Beijing-based HAO Capital with over $500 million under management. Previously, he spent eight years at Goldman Sachs, and was an executive director in the investment management division of Goldman Sachs International in London. He also worked at Charterhouse Development Capital and Morgan Grenfell & Co. previously.

Simon Eckersley: HAO Capital-Invested Chinese Medical Equipment Maker Eyes Major Acquisitions

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China Money Podcast is a top rated talk show series focused exclusively on investing in China. With prominent guests ranging from China-focused fund managers, economists to analysts, the podcast is widely followed by the investment community in and outside of China. Hosted by Nina Xiang, a Beijing-based veteran financial journalist, the podcast is the source of insights on-the-go for anyone interested in learning more about investing in China. More information at ChinaMoneyPodcast.com.

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