East Harbor Takes the Lead, Who's the Next Jinglin?

Private equity going overseas is driven by both the need for asset allocation and the demand for fundraising.

For private equity firms, obtaining a Hong Kong Type 9 license is not easy, and there are still many challenges in adapting to the overseas market environment, building an investment research team, and gaining the trust of institutional investors.

As 2024 has passed two-thirds of the year, why do the performances of private equity firms with billions in assets differ by nearly double?

A major reason for the performance divergence is the difference in allocation direction.

This year, some leading private equity firms have increased their overseas market allocation through public mutual funds like QDII-ETFs, achieving better investment performance.

Going overseas has become the key to the performance of private equity institutions and a new trend in the development of private equity in recent years.

In addition to the motivation for asset allocation, seeking new market opportunities from the fundraising side and dealing with changes in the regulatory environment are also important reasons for private equity to go overseas.

How exactly do private equity firms go overseas?

It is understood that the common methods currently are: first, using RMB funds within the territory to allocate overseas assets, such as through public mutual funds QDII products, or through total return swaps and other derivative tools to invest in overseas markets; second, obtaining a Hong Kong Type 9 license to establish a Hong Kong asset management subsidiary to achieve a complete overseas allocation of assets and liabilities.

According to incomplete statistics from the Private Equity Ranking Network, as of August 5th this year, 98 domestic private equity institutions have obtained a Hong Kong Type 9 license.

The challenges are also considerable.

Private equity going overseas needs to face new regulatory rules and business environments, and at the same time, it puts higher demands on private equity institutions in terms of building overseas investment research teams and asset allocation capabilities.

Leading private equity firms have accelerated their overseas expansion this year, and the performance of private equity firms with billions in assets has continued to diverge.

According to data from related channels, as of mid-August, some products of private equity firms with billions in assets such as Oriental Harbor and Hainan Xiwa have taken the lead in performance this year, while many other private equity products have seen significant declines, with the annual return rate of the leading and trailing private equity firms with billions in assets even differing by nearly double.

A major reason for the performance divergence is the difference in allocation direction.

With a heavy position in overseas assets, leading private equity firms such as Oriental Harbor and Jinglin Assets have achieved relatively better investment performance.

It is understood that overseas assets are becoming a key direction for asset allocation for many leading private equity institutions, and the acceleration of leading private equity firms going overseas is becoming a new trend in the industry.

The common ways for leading private equity firms to go overseas are mainly two paths: first, using RMB funds within the territory to allocate overseas assets; second, directly obtaining overseas licenses to establish asset management subsidiaries to engage in overseas asset management business.

The way to allocate overseas assets within the territory is currently very popular in the market, which is to indirectly allocate through public mutual funds QDII-ETFs.

According to the semi-annual report of public mutual funds, the products of Dongfang Harbor, which have taken the lead in performance this year, have bought 8 Nasdaq ETFs on the market, including China Merchants Nasdaq 100 ETF, and have significantly increased their holdings in the first half of the year, with a total market value of about 1.02 billion yuan.

Multi-asset strategy private equity firm Dunhe Assets has also made a large purchase of several QDII-ETF funds that allocate overseas markets in the first half of the year, including Nasdaq, India, and Japan QDII-ETFs.

Performance data show that the average return of QDII funds so far this year has reached 3.05%, far exceeding other types of funds.

Due to a large amount of allocation demand, public mutual funds QDII products have been facing tight quotas and varying degrees of high premiums this year, which cannot solve the scale problem of private equity allocating overseas assets.

It is understood that the total return swap (TRS) is another important way for domestic private equity funds with billions in RMB funds to allocate overseas assets.

Some institutions have made a large scale of TRS income swap.

This method refers to the cash flow exchange of the income of specific assets with securities firms within a certain period in the future, enabling investors to indirectly obtain the return of the market or asset through total return swap derivative tools when they cannot directly invest in certain markets or assets.

This is considered to be a relatively compliant way for domestic RMB funds to directly allocate overseas assets.

"Due to the demand for overseas allocation, the total return swap has become a very fast-growing allocation direction in the past two years, and it is also one of the most profitable international business varieties of securities firms at present.

However, the total return swap also faces higher costs, including the interest cost of the US dollar, the overnight cost, and the fees of the securities firms themselves, about 5% per year."

Some industry insiders said.

On this basis, many leading private equity firms choose to directly go to Hong Kong to obtain the Hong Kong Type 9 asset management license, issue products to raise US dollar funds, and go overseas completely on both the asset and liability sides.

According to incomplete statistics from the Private Equity Ranking Network, as of August 5th this year, there have been 98 domestic private equity institutions that have obtained the Hong Kong Type 9 license, among which private equity firms with billions in assets have reached 21, accounting for nearly a quarter of the total number of private equity firms with billions in assets, including representative institutions such as Jinglin Assets and Oriental Harbor.

Looking at the timeline, the speed of leading private equity firms going overseas to obtain licenses has obviously accelerated in recent years.

The first batch of private equity firms going overseas in the territory started to obtain licenses in 2003, and in 2005, Jinglin Assets, as a leading private equity firm, took the lead in obtaining the Hong Kong asset management license to start overseas business.

In 2015, leading private equity firms such as Baoyin Assets, Danshui Spring, Qianhe Capital, Oriental Harbor, and Chongyang Investment successively went overseas through the Type 9 license, and by 2019, a total of 16 leading private equity firms had completed going overseas.

After 2020, the speed of leading private equity firms going overseas to obtain licenses accelerated, with a total of 17 obtaining the Type 9 license, exceeding the number of the past 17 years, and the total number reached 33, among which Evolution Theory Assets, Central European Ruibo, and Qianxiang Assets are the new representatives of private equity going overseas in recent years.

Behind the acceleration of private equity going overseas, why have leading private equity firms accelerated going overseas in recent years?

A partner of a private equity institution with plans to go overseas believes that private equity going overseas has both the motivation for asset allocation and the demand for fundraising.

"From the perspective of assets, due to the obvious trend of global market differentiation, it poses new challenges to private equity institutions that mainly pursue absolute returns, and allocating funds overseas can better grasp opportunities and balance risks."

The above private equity institution partner said, "From the perspective of liabilities, due to the relatively low market performance, private equity currently faces a large 'difficulty in fundraising' problem in the domestic market, and even some leading star private equity fund managers' new products have raised less than tens of millions of yuan, while the duration of domestic funds is generally short, and they are more sensitive to market fluctuations, making management more difficult.

Therefore, private equity hopes to go overseas to seek new incremental market opportunities and more long-term capital sources."

It is understood that many leading private equity firms that allow for allocation conditions also said they will increase the allocation of overseas assets and make more global asset allocation by diversifying investment risks.

"Overseas assets may be a direction that domestic investors cannot ignore in the future."

Some institutions said.

In addition, there are some reasons for products and operations for private equity to accelerate going overseas.

With the continuous standardization and strengthening of private equity supervision, private equity needs to face stricter and stricter regulatory environments.

The "Private Equity Securities Investment Fund Operation Guidelines" officially came into effect on August 1, and there have been changes in supervision of the private equity industry from products, operations to net value disclosure, and many private equity managers have carried out a large amount of self-inspection and rectification around the new regulations this year.

"The Hong Kong market's regulatory focus on asset management institutions is more on the information disclosure dimension, such as the information disclosure requirements for law firms, accounting firms, investment banks, and listed companies are very strict, while the product, investment, and trading aspects are relatively more liberalized, which attracts leading private equity to go overseas to Hong Kong."

The person in charge of the private equity that has completed going overseas introduced.

It is worth noting that in recent years, quantitative private equity has accounted for an important proportion in private equity going overseas.

Data shows that among the 17 leading private equity firms that accelerated going overseas after 2020, quantitative private equity has reached 10, accounting for nearly 60%, including institutions such as Ming Shi Fund, Tianyan Capital, Jiukun Investment, Qianxiang Assets, Jinge Quantitative, and Frontier Assets.

Why do private equity firms with billions in assets choose Hong Kong as the first choice for going overseas?

The views of industry insiders suggest that Hong Kong has a geographical advantage.

Hong Kong is closer to Shenzhen and other mainland areas than Singapore, and it is more convenient for many private equity institutions, especially those in the Shenzhen area, to go to Hong Kong.

Secondly, from an investment perspective, Hong Kong has a complete financial and legal infrastructure, and the Hong Kong stock market is larger, making it more convenient to invest than Singapore; at the same time, in terms of financing, Hong Kong is also more suitable for mainland institutions to carry out fundraising and other market activities.

Finally, from a policy perspective, the country has also clearly proposed to support Hong Kong in enhancing its position as an international financial center, strengthening the function of an international asset management center, and deepening and expanding the interconnection of the mainland and Hong Kong financial markets.

Private equity going overseas is also not smooth sailing.

In fact, private equity going overseas needs to be familiar with overseas new regulatory compliance requirements and business environments, and applying for a Hong Kong Type 9 asset management license also faces certain thresholds.

The Hong Kong Type 9 license is a Type 9 regulated business qualification license for asset management issued and implemented by the Hong Kong Securities and Futures Commission under the "Securities and Futures Ordinance," that is, an asset management license, and companies with a Type 9 license are qualified to provide domestic and foreign institutions with stock, fund, bond, and other investment portfolio management services.

The Hong Kong Securities and Futures Commission's second quarter report shows that as of June 30, the number of companies licensed to conduct Type 9 regulated asset management activities reached 2,161, an increase of 21 from the previous quarter.

"Applying for a Hong Kong Type 9 license requires providing the Hong Kong Securities and Futures Commission with a clear business and operational plan, designating two business responsible personnel with rich experience in asset management and good compliance records, configuring licensed representatives, and meeting the minimum application requirements in terms of capital, compliance and risk management, and corporate governance."

Industry insiders introduced.In the view of the general manager of a private equity institution that obtained a Hong Kong Type 9 asset management license in 2020, the difficulty of obtaining a Type 9 asset management license in Hong Kong is roughly equivalent to about three times that of a domestic private equity license.

"The Type 9 license is a more comprehensive negative list system asset management license that includes securities, equity, and more.

First, various costs including lawyers' fees are higher than in mainland China, secondly, the requirements for managers' qualifications and compliance are stricter, and the difficulty of the professional qualification exam is also higher.

We spent two to three years, from initially planning to set up a new company, to finally acquiring a Type 9 license in Hong Kong indirectly by purchasing a company that already had the license."

At the same time, moving from mainland China to Hong Kong requires adapting to a completely new regulatory and business environment.

"Compared to the mainland, the Hong Kong market has very strict regulations on information disclosure and sources of funds, which requires starting from scratch.

They spent a lot of time adapting to these aspects and also paid a relatively high learning cost," said the general manager of the aforementioned private equity institution.

Some private equity institutions have obtained the Type 9 license more quickly.

Quantitative Investment is a quasi-billion-yuan quantitative private equity established at the end of 2019 and obtained the Type 9 license at the beginning of 2024.

"We began preparations to go overseas in the middle of last year, preparing for professional exams, submitting materials to the Hong Kong Securities and Futures Commission, and obtained the license at the beginning of this year, taking about eight to nine months," introduced Sun Lin, founder and CEO of Quantitative Investment.

"The difficulty in applying for the Hong Kong Type 9 asset management license mainly lies in the strict review of managers' qualifications.

Both of our partners have experience working in large overseas institutions.

I personally have worked at Barclays Capital and Two Sigma for nearly ten years, and Yu Hang has had many years of experience at Knight Capital and Tower Research.

This is a professional background that is recognized overseas and is also one of our advantages."

For private equity institutions, overseas fundraising also poses certain challenges.

It is understood that the overseas market is generally dominated by institutional investors who value mature investment philosophies and asset allocation capabilities.

In addition to a few early private equity institutions that have overseas university endowment funds and sovereign fund clients, most private equity institutions that have gone overseas in recent years are still in the exploratory stage of fundraising.

As a "newcomer," they still face significant trust issues.

"Overall, investors first trust international investment banks such as Morgan and UBS, followed by Chinese securities firms or public funds such as CICC and CITIC International, while this batch of newly overseas private equity institutions are currently in the third echelon, with most clients still being mainland clients coming to Hong Kong," said an industry insider.

Sun Lin said: "Overseas institutional investors generally value the Sharpe ratio more, and they have higher requirements for transparency than domestic investors, especially caring about the risk control of managers."

On the investment side, the overseas market also sets higher requirements for the construction of private equity institutions' research teams and asset allocation capabilities.

"Domestic private equity institutions, due to their relative unfamiliarity with overseas assets, face a sharply increased research difficulty in allocating overseas assets.

They need to build a research team that is adapted to it, which is often an area that requires long-term investment and accumulation for many private equity institutions, and there is actually a big gap in this area," said an industry insider.

Among private equity institutions, Jinglin Assets, which has been developing overseas for nearly 20 years, has relatively mature overseas asset allocation and research capabilities.

Jinglin obtained the Hong Kong Type 9 license in 2005, and about half of its funds are allocated to overseas assets, including Chinese concept stocks and US stocks.

As of the end of the second quarter of 2024, Jinglin Asset Management Hong Kong Limited held a total of $3.795 billion in assets, equivalent to about 27.2 billion yuan.

Currently, Jinglin has built a research team of more than ten people in Singapore, covering global market research in North America, Europe, Southeast Asia, and other regions.

"This kind of global research platform is very helpful to us, and we have also invested a lot of resources and costs to build this global research system based on international competitive comparison research," said Jinglin.