Abstract: In recent years,China's private equity market has undergone significant development and maturation.Compared with direct investment funds,Funds of Funds (FOFs) have developed rapidly by virtue of their qualities such as diversified investment risks,professional service management,and access to high-quality investment opportunities.Through empirical research,this paper analyzes the investment performance of private equity FOFs in China and explores the underlying factors that influence  the FOF performance.

This study analyzes performance variations and potential drivers of diverging performance across different types of private equity FOFs unique to the Chinese market.Our results suggest that FOFs underperform against direct investment funds.Limited partners with FOF background exhibit higher investment performance compared to those with a government background,but lower compared to those with enterprise,financial institution,and other backgrounds.Moreover,government-guided funds have significantly lower performance than market-oriented FOFs. Between the two market-oriented FOF types,state-owned FOFs have demonstrated superior performance in comparison to private FOFs.The performance of diversified FOFs is superior to FOFs with focused investments.Simulation sampling demonstrates that synthetic FOFs outperform real ones,indicating that the FOFs in the private equity market of China lack the ability to screen high-quality sub-funds.A preliminary investigation into the insufficient screening ability of FOFs suggests that the unsatisfactory screening ability of government-guided funds substantially diminishes the overall screening proficiency of FOFs.Despite considering the policy limitation of prioritizing local and early-stage investments,government-guided funds continue to exhibit inadequate screening capability.

The paper presents four primary contributions.Firstly,it conducts a pioneering and comprehensive examination of the investment performance of FOFs in China's private equity market from multiple perspectives.Moreover,it scrutinizes the factors behind the FOFs' performance and their capacity to evaluate sub-funds under various circumstances using various approaches.These analyses expand the frontier of academic research on the FOF performance.

Secondly,this study utilizes a novel calculation method to objectively evaluate the performance of Chinese FOFs based on the characteristics of the data available for Chinese private equity funds.International databases,such as Preqin,disclose the cash flow data of funds.Consequently,researchers can calculate the Internal Rate of Return (IRR) directly or utilize the Public Market Equivalent (PME) values provided by the database.However,cash flow data remains unavailable in China,and mainstream databases only offer IRR and investment multiples for each exit.Therefore,to calculate the investment performance of a direct investment fund,this paper employs the successfully exited projects' investment amount divided by the fund's total investment amount as a weight.The weighted average of the internal rate of return (investment multiple) for the successfully exited projects is then used to approximate the fund's internal rate of return (investment multiple).Meanwhile,this paper uses the successful exit ratio and IPO ratio of the fund's investment as measures of the fund's performance.Regarding FOFs,the investment performance is approximated by weighting the sub-fund performance (internal rate of return,investment multiple,successful exit ratio,and IPO ratio) by the ratio of a FOF's investment in the sub-fund to its total investment amount.None of the prior literature assesses the performance of China's FOFs or private equity direct investment funds using the aforementioned four metrics simultaneously.

Thirdly,based on Chinese characteristics,this paper innovatively studies the performance of FOFs at three levels,i.e.,it studies the performance differences between FOFs and direct investment funds,the performance differences between FOFs as LPs and LPs from other backgrounds,and the performance differences between FOFs from different backgrounds.In particular,the performance differences between the three camps of FOFs in the Chinese market,namely,government-guided funds,private FOFs,and state-owned FOFs,are studied for the first time.This paper enriches the literature on the performance differences of FOFs with different backgrounds.

Fourthly,this paper conducts random sampling using R to simulate the investment portfolio of the FOF as a way to determine whether the FOF can achieve better performance by selecting high-quality sub-funds.In particular,based on the local bias and the preference for early-stage funds in government-guided funds,we evaluate the ability of government-guided funds to select sub-funds through stochastic simulation.This is a dimension that has not yet been considered in the classic literature such as Harris et al.(2018).Our paper pushes forward the frontier of research in this regard.

In addition to the theoretical value,this paper also holds practical significance.The performance difference analysis in this paper can provide guidance for various types of China's FOFs,especially government-guided funds,to further reduce costs,improve investment efficiency,and enhance investment skills.For investors,the analysis in this paper can help them choose the right type of FOF and management style,and enhance the return on capital.For fund managers,it can facilitate them to make peer comparisons,summarize lessons learned in a timely manner,and enhance the efficiency in competition among different funds.Additionally,the methodology presented in this paper can aid supervisory authorities to scientifically evaluate fund performance,leading to more effective supervision and increased efficiency in the private equity market's support of the real economy,entrepreneurship,and innovation.