36Kr CEO Feng Dagang Summit Dialogue with Gopher Asset Management Chairman Yin Zhe: S Fund is a PE Investment with Better Liquidity 丨 2021 China Investor Future Summit

"Transcendental" means something that is beyond all possible experiences and cannot be thought of with conventional thinking and empiricism. In this "transcendental era" of ups and downs and uncertainties, how will investors rely on the core competitive "super" capabilities such as interdisciplinary rapid self-iteration ability, keen discernment ability, and forward-looking predictive ability to operate in the capital market?

On September 23-24, 36Kr "Transcendental Era - 2021 China Investor Future Summit" was held in Shanghai, where 100 mainstream investment institutions gathered to discuss the known possibilities in the unknown future and re-examine the social responsibilities that capital should shoulder.

As China's private equity market is about to usher in the largest wave of fund clearance in history, the demand for liquidity in China's more than 20,000 funds has become particularly important. Therefore, the S fund (Secondary fund) that carries out the transfer of second-hand shares, also known as PE secondary market funds or private equity secondary market funds, has become a hot topic in recent years.

Pinnacle Dialogue

In the field of S funds, Gopher Assets can be called the "pathfinder" of the Chinese market, as early as 2013, it was established and issued the earliest S fund. 36Kr launched a column "Information Message Board" this year that is very relevant to the concept of S fund, which helps the supply and demand sides quickly establish a connection by providing some asset transaction clues.

Are S funds looking for faster exits and shorter investment cycles, rather than higher returns or lower risks? What does the difference in its returns depend on? Which investors are investing in the fund? What are the trends for S-Fund over the next five years? In response to these topics, Feng Dagang, CEO of 36Kr, and Yin Zhe, chairman of Gopher Asset Management, launched a summit dialogue at the summit.

Yin Zhe said that for institutional investors, especially insurance companies, "the S Foundation is a very favored investment method" and "the future S Fund will also have a process of heading and centralization.". But at the same time, he also said that as an important supplement to alleviate the difficulty of PE exit, the market share of S Fund in China will definitely increase. While the complexity of investment will continue, market acceptance will also increase.

The following is the content of the dialogue, compiled by 36Kr Editors:

<h3>What is the complexity of the S Fund? </h3>

Feng Dagang: Gopher's attention to the S Fund has been much earlier than other peers, and it has been involved since 2013, please help us introduce why we entered this field at that time, and what is the basic situation?

Yin Zhe: The essence of all business models is to meet the real needs of customers. Gopher has been doing market-oriented fund-of-funds since 2010, which is the demand for steady allocation for Chinese high-net-worth customers, and the same is true for S funds. In 2013, due to some local economic twists and turns, investors generated demand for PE share transfer in the liquidity process of investing in PE, but at that time, the Chinese market did not have a valuation and pricing system for PE shares, and there were no related fund products.

We studied the overseas PE market practices, the Secondary market is a mature and effective way, so in 2013 Gopher released the first issue of the RMB S Fund. In recent years, the speed of issuance and investment has accelerated significantly. 2015 is the second issue, 2017 is the third issue, 2018 is the fourth issue, due to the epidemic, 2020 is the fifth issue, during which we also issued 2 issues of the US dollar S fund. Obviously feeling that the market demand is increasing, S funds have gradually become a hot topic of general concern in the industry.

Feng Dagang: Now in the sixth phase of fundraising, how big is the scale?

Yin Zhe: The target is about 3 billion yuan, Gopher is currently controlled at a moderate scale for each period, mainly considering that investors in the S fund have more demand for PE liquidity, so the scale cannot be too large and affect investment efficiency.

Feng Dagang: Just mentioned that customer needs triggered the creation of S fund, so why didn't customer needs lead to an equity trading platform at that time, but to prepare to set up a fund?

Yin Zhe: This is a good topic.

PE investment itself is a very complex problem, full of information asymmetry, and the professional requirements for information judgment (including valuation, transaction structure, etc.) are very high. Exchanges can increase the arrival and communication of information to a certain extent, but it may also give the market and ordinary investors some illusions, and easily trade without professional ability.

It is precisely because of the high asymmetry of information and the extremely high requirements for professionalism, so overseas, most of the S fund investors or shares are basically done by the fund of funds or professional institutional investors.

In addition, the fund is a strong bond between the GP and the LP. Not only does the LP choose the GP, the GP is also choosing the LP, and also hopes that the LP is a long-term relationship, and there are many things in the process that rely on each other, so the S fund initiated by the GP also has certain requirements in the choice of LP. Combining these factors, the trading center is an effective supplement to the information exchange of S fund, but it cannot replace the characteristics of the essence of S fund investment.

Feng Dagang: We emphasize the complexity of second-hand fund shares, in such an S fund, is there some change in the needs of investors for GPs and managers, for example, compared with ordinary PE, what are the different needs?

Yin Zhe: This is a very good topic. Defined from a Secondary perspective, its value lies in providing a more liquid PE investment experience. First of all, S fund meets many characteristics of PE investment, such as the investment cycle is also relatively long, through portfolio investment, to obtain a relatively good early investment in the growth of enterprises and bring investment income.

At the same time, why is it called a PE investment with better liquidity? Because when the S fund buys fund shares, it is basically a fund share that already has an investment target, which will save an average of 3-4 years compared with the initial fund.

Feng Dagang: It pursues a faster exit, a shorter investment cycle, and is not pursuing higher returns or lower risks, can it be understood?

Yin Zhe: S Fund has higher requirements for DPI and the speed of payment collection. At the same time, in terms of yield, the average return of PE investment can also be achieved, and in theory, IRR can be the same as the original PE investment.

Feng Dagang: So when you get better liquidity, do you pay any costs?

Yin Zhe: The most important thing is the invisible cost. You may not be able to buy the shares of the fund you want. Trading opportunities depend on whether the second-hand share holder wants to sell or not, and trading opportunities are not always available.

In the past few years, the investment of S Fund does have the logic of picking up leaks, that is, customers have transfer needs, and we just undertake it. Now relying solely on the leak-picking strategy is no longer enough to support the S strategy. In the past period of time, PE investment pressure is very large, the project can not be withdrawn, and the HOLDING cycle of RMB PE investment is very long, which will cause structural restructuring opportunities in the process. Investors in The Secondary Fund are required to take the initiative to create some opportunities, and systematically create opportunities for the overall exit with GPs and mainstream funds in the market. In the future, the trading opportunities of GP-led S fund shares are far greater than the opportunities for leakage.

<h3>Who exactly is investing in S Fund?</h3>

Feng Dagang: Assuming that there are 100 potential investors investing in PE, how many potential investors are there to invest in S Fund? What kind of people would be particularly interested?

Yin Zhe: Our experience and data show that high-net-worth clients who have had PE/VC investment experience in the past will have a higher probability of investing in S funds. If you have no experience in PE/VC investment at all, you will not choose S Fund directly, because you have not yet figured out what S Fund does. Therefore, we say that S fund is a pe investment with better liquidity, which is based on the experience of PE investment to further solve the liquidity needs.

Institutional investors, which are another type of investor, such as insurance funds, which themselves pursue faster DPI returns, will choose S funds as a necessary supplement to better asset allocation. Gopher has been interacting with insurance companies since 3 or 4 years ago, and we also feel that insurance companies have more and more investment needs for S funds.

Feng Dagang: It can be said that it is an investor among investors or a more experienced investor. We see that the target size of the sixth fund is about 3 billion, and in the past few years, it has basically been 2 billion to 3 billion fundraising scale, which is relatively restrained. And many overseas S funds even have a scale of close to 20 billion, there are some very large-scale state-owned S funds, why will Gopher deliberately maintain restraint?

Yin Zhe: We see that overseas S funds have two more important characteristics, one is that they are basically LPs with a fund of funds background to issue S fund secondary, and overseas large fund of funds LPs have a layout in the S fund category. In the overseas market, the market dominated by buyout is generally larger than that of the PE/VC market. In China, it is still in the investment stage of the growth period, and the investment in mergers and acquisitions is relatively small, from this point of view, the volume of market demand is not the same.

Overseas, in recent years, it has been found that the overall market penetration rate of secondary is about 7%. Suppose 100% is a private equity market, where around 7% of the market share is done by secondary. In China, it is only 0.5%, and the volume share is relatively small.

We believe that all investments must return to their essence. After all, Secondary is a private equity investment that needs to be gradually developed along with the overall development of China's private equity market.

Assuming that the scale of the fund is too large at once, it is possible that it will not be able to invest all the time, reducing the efficiency of the use of the S fund and the speed of payment collection. We prefer to run in small steps, on the one hand, quickly complete the fundraising, Gopher S5 will close the account earlier than expected; on the other hand, the reserve investment projects will be invested as scheduled, Gopher currently issued a total of 6.7 billion yuan fund and nearly 100 million US dollar funds, has completed nearly 100 transactions. We hope to build brand reputation and customer trust in the real investment performance, and continue to develop.

I believe that for a long time to come, in the PE ecosystem, Secondary will become more and more important to supplement the force.

<h3>What money does the S Fund essentially make? </h3>

Feng Dagang: What kind of money are we more interested in S Fund? I have seen a profile where the S Fund's usual share is 10% off, does the return we give to our clients depend on this discount? What does the difference in S Fund returns depend on?

Yin Zhe: We have done some in-depth practical empirical research. Secondary funds may take advantage of buying trades. This cheap is like just talking about a bit of a discount. Discounts are discounted based on the valuation of the fund at the point in time of the transaction. Overseas, usually between 10% off and 15% off: the more mid-to-late the fund, the smaller the discount, it may be 10% off - 95% off, and even some good projects will have a premium; the earlier the fund, the higher the discount, and even to 60%.

In China, the development of S funds is relatively short after all, and the pricing cannot be completely discounted. In experience, it is about 20% off, and some discounts are better. The size of the discount really depends on the underlying project, because there are some projects that are close to the IPO and may not have been funded, and his valuation is at this point, and the listing may bring better returns. However, there are also some projects with high valuations, but once listed, they will be inverted, and the price is not as good as the valuation of the previous period of listing. It varies, and the valuation still depends on each project.

Earlier talked about the valuation discount problem, your question is to ask the S fund what part of the profit it essentially earns, but it is not just a buying discount, or even a small part. According to Gopher's past investment experience, in the long run, the value-added part of the project after investment contributes 75% to 80% of the overall income of Gopher S Fund, and the remaining part is contributed by the discount at the time of purchase. This is also why Gopher proposed the meaning of D in the ecosystem of DSG in the process of S investment, that is, the ability to judge the project, or the essence of S fund investment, the essence of PE investment.

Feng Dagang: There are some projects that even if they are very good, we may not necessarily participate, and some projects are quite expensive, but we still have to participate. In essence, it is not to see that each S fund gets better discounts, or the understanding of investment projects. In fact, it is essentially an investment business, and it is made to invest money.

Yin Zhe: This is particularly important. Gopher has gone through several stages of development in the past, starting from the fund of funds, we have cooperated with almost all the heads and dark horse GPs in the market, and we have grown together relatively well. This determines that we can invest in these excellent funds for the first time, and invest in the inflection point of finding a GP in the first time fund, but these are not enough to do S funds.

The core of the S fund is still to have the ability to judge the project, and Gopher continues to develop its industry research and project direct investment capabilities in the process. In this way, looking back at the project valuation can be dynamically looked at, which is a continuous accumulation of capabilities. Suppose you look back now, close your eyes to see how much discount you have, and basically can't get off your hands because you don't dare to do it.

Feng Dagang: Since last year, GP-led S funds have become more and more popular, indicating that S fund transactions are extremely complex, must there be such a transaction structure?

Yin Zhe: As mentioned earlier, GPs are also choosing their own LPs, because investment is a very long process that requires mutual understanding and support. Many LPA agreements have a clause that the GP has the right to determine the counterparty to the LP's share of the transfer, which is a general clause.

Second, GP fundraising has not been as smooth as it has been in the past few years. It can be said that the two heavens of ice and fire are more seriously differentiated. Some head GP pre-fund S fund shares transfer in the hope of giving priority to the next phase of investors. The fundraising of the initial fund has been upgraded to a comprehensive packaging strategy. The GP-led discourse power can be thickened.

In market practice, the three reflect the cooperative relationship of the ecosystem, GP and LP are very important links in the ecosystem, S fund has become a very important supplementary point, the role played in the future may be more important than the present, but it is definitely not dominant, it is an active ecosystem, the role of building the ecosystem.

S fund investment should establish a relatively close long-term relationship with the GP, and at the same time have a very clear understanding and objective valuation of the investment target, so as to invest well.

<h3>What kind of S fund manager will be the winner? </h3>

Feng Dagang: I have seen your speech on building the DSG ecosystem before, what do you think of the ecosystem made by Gopher Assets today? What is the step of the industry's DSG ecosystem today?

Yin Zhe: I think it can be roughly divided into three stages. The first stage, the veteran GP established before 2005, has basically grown into a comprehensive fund after development, and the overall strength and size of the fund are particularly strong. The second stage is the new generation 2.0 version, many of which are teams differentiated from the old GPs, which were established around 2010, and have been ten years now, and the performance has gradually been reflected. There are indeed some survival of the fittest, and the good and the bad begin to come out gradually. In the third stage, the GPs that came out after 2018 are basically industry funds. GPs are becoming more and more diverse and complex.

The investment of The Gopher private equity team is also an ecological organization in the internal play, in the past we called PSD (Primary + Secondary + Direct), and later we upgraded to DSG (Direct + Secondary + Gp), in order to emphasize the importance of GP cooperation, together with the majority of excellent GPs to promote the development of the industry; at the same time, the core of this ecological strategy is to have the project direct investment ability, have the ability to D; S ability is a very important supplement, The three are complementary, but they all revolve around one point, that is, to provide investors with investment products that provide an equal balance between returns, liquidity, and risks, and meet different needs. Investors who invest in Secondary and investors who invest in initial funds, or investors who directly invest in projects, the needs are not exactly the same, it is precisely because of the diversity of demand, resulting in the industry becoming more and more prosperous and active.

Feng Dagang: Some time ago, we launched a column - the modern information message board. It is a column closely related to the s fund, do you think this will be part of the ecology?

Yin Zhe: We have also been paying attention to the information message board. There have been more than a dozen issues of the information message board, which has the opportunity to transfer projects and shares, and purchase opportunities, so that both the supply and demand sides can have a place to provide demand. Media and information platforms are also indispensable links in the entire ecosystem, and only in this way can information become more fluid and active. In the future, it is also expected that 36Kr's information message board will give birth to some new business models to provide better value to this industry.

Feng Dagang: Please predict the industry trend of S fund in the next five years, and what new goals will Gopher Assets have?

Yin Zhe: First of all, due to the long-term role of liquidity, the market share of Secondary Fund Strategy in China will definitely increase. Personally, I think that in 3-5 years, even if the transaction rate of 3 to 5% is reached, there is nearly 6 to 10 times of growth space. Second, the complexity of Secondary investment will continue, which is the embodiment of comprehensive capabilities, and in the future, Secondary Player will have the same process of heading and centralization as abroad. Third, the secondary market acceptance will become higher and higher, which will become an effective supplement to PE investment and become a PE investment method with better liquidity. In the future, it will become a very popular investment method for institutional investors, especially insurance companies.

In this process, the development of S Fund will also play an important role in the prosperity and sustainability of China's PE industry ecosystem, because it is another way to exit or an effective supplement. It also has high value for alleviating the difficulty of PE withdrawal.

Feng Dagang: S fund in China for almost ten years, has gone through the first return cycle, to the first part of the investors to bring returns, the new asset management regulations have also brought new changes to the industry, in the end what kind of S fund managers will be the final winner?

Yin Zhe: We have just invested in the RMB S V fund, which is generally in line with our expectations, and from the perspective of DPI, it is relatively fast, and the speed of payment collection is significantly shortened. In the long run, Secondary investment for the manager of the requirements are getting higher and higher, although 36Kr will provide a lot of information, but too much information after how to distinguish, identify information, find the most valuable investment targets, etc., the difficulty of the work and the complexity of the transaction is very high, it requires the digital transformation of the whole industry.

Gopher has invested in more than 200 funds and more than 6,200 indirect investment projects in the past, and the S fund industry has invested about 100 orders. The digital assets and experience accumulated in the process will provide very important decision support for future iteration and evolution of investment strategies. In the future, only by continuously working harder can we continue to bring better value delivery and investment experience to investors.