In Depth: Impatient State Investors Hamstring Drive for ‘Patient Capital’ to Lead Growth

China's attempt to encourage "patient" capital investment—a focus on long-term returns rather than immediate gains—faces challenges as state investors seek quicker returns on venture capital (VC) and private equity (PE) investments. Patient capital has become a significant policy focus in China, as highlighted in an April Politburo meeting emphasizing investment in advanced technologies. The State Council aims for state-owned capital to play a more significant role in nurturing high-tech industries like artificial intelligence. [para. 1][para. 2][para. 3]

However, state-owned enterprises (SOEs) and government-led funds are struggling with the concept of patient capital due to their performance assessment mechanisms. These assessments, often conducted annually, pressure officials to prioritize short-term gains during their tenure, leading to a preference for quicker financial returns. A source at a PE firm noted that while fund managers are willing to focus on patient capital, they face resistance from state investors who frequently oppose the strategy. This impatience poses a significant hurdle to meeting the government's objectives, especially amid a downturn in private sector investment, leading to a more substantial role for state investors. [para. 4][para. 5][para. 6]

The market is experiencing a downturn, with Chinese VC/PE funds seeing an 18.9% decline in 2023, accumulating $110.4 billion. The challenging year is underscored by a drop in new fund establishment and committed capital. Tightened IPO regulations have also contributed to the shrinking fundraising and investment landscape. The State Council has released guidelines to improve the management system across the VC spectrum, addressing concerns about dwindling funds and limited exit channels. [para. 7][para. 8][para. 10][para. 13]

State investors, increasingly dominant in the yuan-denominated VC/PE funds, contribute to these challenges. Their involvement introduces more state intervention in fund management practices, notably through the alteration of fee structures. Many private equity firms now charge management fees based only on paid-in capital instead of committed capital, reducing revenue for fund managers. This state-driven change is largely due to the yearly assessment cycles of SOEs, which do not align well with the timelines required for investments in innovative sectors to mature. Long-term outcomes are difficult to measure within annual review frameworks. [para. 14][para. 15][para. 16][para. 18][para. 20]

Changes are needed for state investors to genuinely adopt the role of patient capital, such as revising assessment standards and aligning them with the timelines of long-term investments. Some local governments have initiated these changes by adjusting accountability mechanisms for investment losses. However, on-ground impact remains limited. Industry experts argue for separating government funds into distinct roles to attract investment and preserve capital value independently. Allowing longer investment and exit periods is seen as crucial for nurturing true patient capital investments. [para. 22][para. 24][para. 25][para. 26]

Overall, while the concept of patient capital is theoretically appealing and supported by Chinese policymakers, the execution faces practical hurdles due to entrenched practices and assessment cycles that favor short-term gains. The industry's future, particularly the role of state investors, will hinge on successfully addressing these systemic challenges and fostering a conducive environment for the desired long-term investment approach. [para. 29]