A grain of sand for the era, a mountain for USD funds

By Zhiyan Chen and Lili Yu

Edited by Jing Liu

The Chain Reaction in Dollar Funds

Things are changing.

Over the past two weeks, the world of Chinese concept stocks has shifted dramatically. When markets closed on March 14, the Nasdaq Golden Dragon China Index (HXC.O) — widely considered the most accurate barometer of U.S.-listed Chinese companies — finished at 5,181.3, down 11.7%. It was the largest single-day drop in the index's history. The previous record dated back to 2008, when the financial crisis erupted.

On the same day, the KraneShares CSI China Internet ETF (KWEB), known as the largest overseas China stock ETF, plunged over 11%. Since 2022, the fund has fallen more than 40%, wiping out all gains since its 2013 listing. Nine years of returns, erased overnight.

This was the day market sentiment reached its peak intensity. From early 2021 through March 14, 261 out of 280 U.S.-listed Chinese stocks had declined. Even looking at just the year-to-date, 184 Chinese concept stocks had fallen more than 20%, with 53 down by half or more. Over the past two days, Undercurrents learned from multiple dollar fund professionals that they too had suspended investments: "Every deal with a term sheet but no SPA is on hold."

Investors are experiencing unprecedented self-doubt. "We need a major transformation," a growth-stage investor at a well-known dollar fund told us pessimistically. Their tried-and-true Growth/PE strategies may no longer work. Some dual-currency funds have been holding密集 meetings to discuss whether new transaction opportunities exist beyond financial investments — such as buyouts.

Historically, every time Chinese concept stocks have faced turbulence, dollar funds have inevitably been caught in the crossfire. The Luckin Coffee accounting scandal in early 2020 comes to mind. But this situation is different.

Over the past two decades of China's new economy wave, dollar funds have been an undeniable mainstream force. In the domestic primary market, compared to RMB funds, dollar funds have long held absolute话语权. Especially following post-pandemic dollar oversupply, most dollar funds in China raised unexpectedly large sums between 2020 and the first half of 2021. Single fundraises of $1 billion — once unimaginable for VCs — became commonplace for a time.

In the recollection of Jianping Gan, founder of INCE Capital, as of June 30 last year, multiple U.S. university endowments — among the key LPs backing top-tier dollar funds — reported their highest-ever returns. "Some were 50%, even 60%," he said. "Bear in mind, we're talking about hundreds of billions of dollars returning 60%." Of course, this wasn't necessarily attributable solely to China.

The inflection point arrived last July. When online education — a sector heavily bet on by numerous dollar institutions, especially mega funds — collapsed, the long-term fate of dollar funds in China became a topic of repeated discussion. This January, official media outlet Securities Times published an article noting that dollar funds currently "can't invest in hard tech" and "struggle to raise RMB."

This latest violent fluctuation in Chinese concept stocks has undoubtedly intensified dollar funds' survival anxiety. It directly undermines the foundation they've long stood upon: invest in new economy companies, build offshore holding structures, list on overseas exchanges, exit and recycle capital. While on the surface later-stage PE funds appear most affected, if conditions don't improve, dollar funds at any stage will struggle to escape unscathed.

Over the past two days, Undercurrents interviewed multiple dollar fund professionals. Many could barely conceal their anxiety. One investor who recently joined a mega fund told us that as someone with five or six years in the industry, he used to only care about company and sector dynamics — but these past few days, he's read more analytical articles than perhaps in his entire life, trying to understand what is happening to his industry.

Yes, if you want to survive in a great era, watching your feet alone is far from enough. You need to look up at the sky.

The Migration of the "Pecking Order"

They may work in the same CBD, chat in the same coffee shops, or co-invest in the same company. But everyone knows that, for a long time, a "pecking order" has existed between dollar and RMB investors.

The broad outline: one is a dollar market focused on internet and new economy companies, with overseas stock market exits as the dominant path; the other is an RMB market that more heavily bets on industrial applications and certainty-driven opportunities, with A-share exits at its core.

No currency is inherently superior, yet a subtle power dynamic lurks between dollar and RMB funds. At the LP level, the judgment capabilities of dollar versus RMB investors are clearly not equivalent. Dollar funds raising RMB funds are common in the market, while RMB funds successfully raising dollar funds are exceedingly rare.

At Hongtai Fund's fifth anniversary conference in late November 2019, founder Xitai Sheng declared before employees and LPs: "Without a dollar fund, there's no food on the table." As a representative本土 fund, Zhongding Capital founding partner Yan Li only felt he'd "taken a seat at the main table of the primary market" when raising his second dollar fund. For a long time, dollar funds raising RMB was seen as a strategy to hedge currency cycles, while RMB funds successfully raising dollars carried an air of "endorsing the team's investment capability."

Around the 2009 launch of the ChiNext board, a group of prescient dollar GPs including Hongshan and IDG Capital began raising RMB funds — though this never seemed an inevitable choice for dollar funds. Over the past four years, when Undercurrents interviewed multiple typical dollar investors about RMB funds, their attitudes remained notably ambiguous: basically "paying close attention, but taking limited action."

Warburg Pincus and DCM, two dollar institutions with considerable stature in capital markets, still don't have truly meaningful RMB funds. However, we understand that Warburg Pincus is actively preparing an RMB fund; DCM told us in a 2020 interview that they had established an RMB entity.

The "sense of superiority" dollar funds held in China's primary market also manifested in "stereotypes" about practitioners on both sides. Dollar fund operators tend to have overseas educations and finance backgrounds — "innovation evangelists" pursuing world-changing ideas, "friends of time" riding through cycles. RMB fund practitioners, meanwhile, were described as having "government backgrounds," "industrial attributes," or simply being "grassroots" and "down-to-earth," investing in unsexy companies that couldn't save the world.

In that same year when Sheng vowed that Hongtai would raise dollars "no matter how hard," over 30 Chinese companies listed in the U.S.: Jumei, Yunji, GSX, DouYu, Youdao, FangDD, Q&K International, Lizhi FM... Scan their investor lists, and they're almost exclusively dollar funds. Where RMB funds appeared, they were mostly dual-currency funds that started with dollars.

This was already a microcosm of U.S.-China capital relations in China's primary market over the past twenty years. Tongchuangweiye founder Weihe Zheng once said: "Over the past 20 years, dollar and RMB funds competed on the same stage, but the most profitable case was still ByteDance. SIG alone created glory through this single project. Will there be returns of tens of billions of RMB in the next 20 years? That may be a goal you can hope for but hardly expect." You could quickly read the complex emotions in this RMB veteran's words — envy, helplessness, and a trace of不甘.

At the core of all this: where the money comes from. Domestic dollar fund capital sources fall into four categories: 1) Foreign institutional dollars, represented by "long money" such as endowments and pension funds; 2) Overseas Chinese capital, such as various family offices; 3) Foreign wealth funds; 4) Dollar capital from Chinese institutional investors. The largest and most prized share comes from foreign institutional dollars.

"Dollar GPs aren't more capable than RMB GPs — they just have better capital," the manager of an internet entrepreneur's family office emphasized to Undercurrents. People widely misjudge dollar funds' abilities: many fail to recognize that dollar funds' past success "wasn't personal intellectual success, but success of the American capital model."

After years of development in overseas capital markets, this "long money" has formed mature "asset allocation concepts" regarding Chinese equity investment — namely, "take $10 out of $100 to bet on high-risk, high-reward opportunities." This gives dollar funds average investment horizons of 12-14 years. Patience correlates with appetite for innovation. More patient, longer-cycle dollar capital can strongly drive innovation, becoming fertile ground for outsized returns over the years.

By contrast, RMB funds, constrained by LP return requirements, typically adopt "5+2" term structures. This makes RMB more inclined toward certainty-driven projects, thereby diminishing its voice.

On another front, RMB GPs face far more complex "special requirements" from LPs. "RMB GP behavior is distorted by multiple parties: fund-of-funds, insurance capital —穿透到底, still largely government money pursuing certainty; government guidance funds where political achievement outweighs profit; industrial capital with its own entrepreneur and listed company considerations," one RMB fund investor told Undercurrents.

Another factor is exit channels. Before the STAR Market's emergence, the A-share market — RMB's core exit channel — had explicit profitability requirements for listed companies. This fundamentally blocked the path for internet companies, which had been mainstream in Chinese commerce for over a decade, to list domestically. "In terms of审批, A-shares are stricter than Hong Kong, which is stricter than U.S. stocks. U.S. stocks are more flexible with better liquidity," a fund management company's Chinese concept stock expert analyzed for Undercurrents. Combined with the decade-long bull market in U.S. stocks starting in 2009, this made the main stage for China's internet mythology dollar funds and overseas markets.

Characteristics on the fundraising and exit ends also directly shaped dollar and RMB funds' divergent investment choices: RMB funds typically favor stable, policy-favored projects, while dollar funds prefer higher-risk frontier tech and internet companies.

The difference between these two types of companies, placed against the business world of the past decade, evolved into the hierarchy of status and话语权 between dollar and RMB funds.

But now, when the LP mindset and exit channels that dollar funds in China have long relied upon are both shifting, their fate is tied to more than momentary fluctuations in Chinese concept stocks.

An Unsolvable Puzzle

In recent years, waves of dollar fund decline have surfaced from time to time. A key variable behind this: the strengthening RMB market.

Take the frequently discussed issue of RMB funds' overly short lifespans — this has actually improved somewhat. An RMB fund partner told Undercurrents that among RMB LPs, insurance capital, education foundations, and mature fund-of-funds all represent relatively long-term capital. Indeed, in last year's large RMB fundraises, insurance capital has become a key force. For instance, market rumors suggest that in Source Code Capital's recent raise of over 7 billion RMB, ten insurance funds participated.

However, multiple dollar investors we interviewed believe that their greatest challenge right now isn't the LP question (for top-tier dollar funds, this matters even less), but rather the collective pivot of domestic capital markets.

When hard tech becomes an overarching logic lurking behind nearly every industry, dollar investors' project anxiety reaches unprecedented levels. Beyond questions of these projects' return potential and timelines, "you even need to deal with finding land, building factories, and long-term engagement with local governments to gather resources," one dollar investor noted — completely outside his existing competencies. This basically represents the view of most dollar investors Undercurrents has contacted.

So some dollar investors began searching for new "internet-style" opportunities. Web3, for example. One post-85 dollar fund investor noticed peers migrating from education, consumer, and fintech toward Web3. But this path isn't the optimal outlet for China's dollar fund investors either. "To invest in Web3, you still need to source abroad, while承受很大的社会压力. Beyond that, Chinese Web3 entrepreneurs aren't advantaged — the mainstream remains with European and American founders."

Still, an overseas fund-of-funds that invests in Chinese dollar funds told us that many dual-currency GPs are already actively deploying in "typical RMB projects" like intelligent manufacturing and industrials. "This may not be what VCs want, but for dollar PE, there are actually some opportunities here."

Another necessary piece of context — as the China head of a well-known overseas fund-of-funds told Undercurrents in an interview, a shortage of venture capital projects now exists globally. "Hongshan doing perpetual funds, Tiger aggressively deploying into VC — one moving backward, one moving forward, both indicate this to some extent."

At the fork in the road of an era, talent is the more sensitive weather vane. Once, due to different compensation systems, different back-office efficiency, and that intangible "status symbol," few dollar fund practitioners would join RMB institutions. Recently, however, a veteran financial headhunter told us, "Many people have actively reached out recently, saying they want to look at RMB (dual-currency) opportunities."

An investor at a state-owned fund told us that in recent years, institutions like CMB International have successively recruited numerous senior professionals from dollar funds like Goldman Sachs, Hongshan, and IDG — "promotions are even two levels up, say from associate to director," "compensation can not only match but even exceed."

But none of the above means RMB funds will replace dollar funds.

In Jianping Gan's view, dollar funds currently face no obstacles exiting in the A-share market. "Except for companies requiring ICP licenses, dollar funds have no exit issues whatsoever." "Registering a Sino-foreign joint venture now is much easier than five years ago." "In the past two years, whether biotech or semiconductors, many of the best A-share listings and valuations involve dollar funds, and many founders themselves are foreign-born Chinese."

Regarding the current state where many entrepreneurs prefer RMB, he added: "Perhaps at early stages, but if you want big money, you still need dollar funds." Behind this lies a long-standing invisible logic between primary and secondary markets: for a quality project, only when large institutional investors in the primary market have deployed significant capital will secondary market investors take the other side. From a global capital scale perspective, dollar dominance is unlikely to change in the near term.

The head of a consulting service for equity investment institutions told Undercurrents that despite RMB funds' aggressive momentum, dollar funds still operate more flexibly at the capital level. For instance, dollars can directly distribute stock to LPs and take carry on stock, while RMB cannot.

Meanwhile, the RMB fund market still has numerous chronic ailments awaiting resolution. In the view of one third-party fundraising机构负责人, RMB is a more complex ecosystem requiring capabilities, experience, and background that demand GPs be masterful multitaskers.

He offered examples: When facing a government guidance fund, you may need various performance assessments and data collection — contribution to economic indicators, fulfillment of返投 ratios, tax contributions, and continuity issues after leadership changes. When facing insurance capital, if they're highly focused on generating current income, you may need to sell old shares at a discount, which undoubtedly impacts financial returns.

Beyond this, the RMB market's返投困境, fund lifespans, capacity for large commitments, and other issues remain unresolved.

So this is a problem without a clear answer: even if dollar fund contraction is the trend, this doesn't necessarily lead to a world entirely of RMB funds. Regarding the future of dollar funds in China, it's difficult to reach a旗帜鲜明 conclusion in the short term. Many directly related, indirectly related, and even seemingly unrelated factors could completely overturn the answer. But isn't this precisely the characteristic of our era: beyond conviction, nothing is immutable.

Image source: Visual China

Layout: Yunxiao Guo