Beijing-backed technology funds with almost $900bn under management are struggling to hit their profit targets, according to executives who say their capital is stuck in companies that cannot launch initial public offerings and are unattractive to investors.

“Traditional exit strategies for private equity funds do not work well for us,” an executive at Zhongyuan Science Innovation Venture Capital, a state-backed investment fund in central Henan province, told the Financial Times.

“Our investment decisions have more to do with policy considerations than market principles,” added the executive, who asked not to be named.

Since its inception in 2015, ZSI, which has invested in more than a dozen start-ups in one of China’s poorest provinces, has been unable to offload stakes in two-thirds of its portfolio companies.

These range from agricultural machinery makers to social media sites, many of which are barely making ends meet. As a result, ZSI is unlikely to meet its six-year divestiture deadline in December.

ZSI is just one of thousands of Chinese government guidance funds, or GGFs, that may not be able to liquidate their investments on time. GGFs, which operate akin to private equity funds, represent one of the most significant efforts by Beijing to nurture homegrown innovations as US-China rivalry squeezes the amount of western technology available to the world’s second-largest economy.

The initiative has come under scrutiny, however, as GGFs’ policy-driven investment strategies and market-based performance targets run into conflict.

“There is going to be a real reckoning for government guidance funds,” said Andrew Collier, managing director at Orient Capital Research in Hong Kong.

While Chinese GGFs emerged in the early 2000s, they did not take off until 2014, when the state council announced plans to expand the industry aggressively to address tech start-ups’ funding shortage.

The initiative was meant to replace direct government subsidies, which Beijing began to curtail in the mid-2010s when the practice came under pressure for being inefficient and undermining fair competition.

This led to a surge in GGFs, whose capital came from central and local fiscal budgets. Chinese provinces and cities hoped the investment vehicles could build industry champions.

By the end of March, China had 1,877 GGFs managing a total of Rmb5.7tn ($892bn), according to Zero2IPO, a Beijing-based consultancy. A decade earlier, there were 71 funds with Rmb83bn under management.

“GGFs are one of the biggest and most active players in China’s private equity industry,” said Li Lei, an executive at a Beijing-based GGF. “No one can rival the governments’ resources.”

Column chart of Rmb bn showing Amount raised by Chinese private equity funds and government guidance funds

The investment boom did breathe life into some local businesses. Nio, a once struggling electric vehicle maker, had a change in fortune after receiving a Rmb7bn investment last April from three GGFs. Shares of the New York-listed auto company have since surged more than 10 times as the firm reported a jump in sales.

The successful bet on Nio, however, followed numerous failures. Public records show Chinese GGFs have cashed out from less than a quarter of portfolio companies that had received funding for more than six years. That has put many funds, which are nearing the end of their lifecycle, under stress as they struggle to execute their exit strategies on time.

As with PE funds, most GGFs are structured on a fixed-term basis so their capital can be reallocated to new investments.

“I can’t think of a quick fix to the problem given our flawed business model,” said Li, who faces a December deadline to divest from seven companies.

Poor investment decisions are partly to blame for the exit delay. Most GGFs, especially those financed by local governments, face geographic and industry restrictions on where they can allocate their funds. Such requirements are driven more by policy priorities than business logic, and have given rise to numerous underperforming investments.

Li said her fund, backed by the Beijing municipal government, has a mandate to invest at least 70 per cent of its money in speciality chemicals and advanced manufacturing firms in the capital, where such industries are under-developed.

“We had to buy into unqualified companies to meet the quota,” Li said. “That took a toll on investment outcomes.”

To improve performance, many GGFs have changed their start-up-driven investment strategy to focus on established firms that are seeking an IPO, the traditional exit channel for private equity funds.

The pivot was impaired, however, by Beijing’s decision to tighten stock listing approvals this year to protect investors. Official data showed almost half of IPO applications on Shanghai and Shenzhen bourses failed to proceed in the first four months of this year.

“We have given up hope of divesting through IPOs given the regulatory tightening,” said Wang Zhi, an investment manager at a GGF based in Zhejiang province.

With few other options and liquidation deadlines approaching, some GGFs have decided to offload their investments at smaller-than-expected profits — or even take losses. In April, Wang’s fund sold a stake in a local machine tool factory it bought five years ago for a 20 per cent gain, a low return by industry standards.

“Our priority is to meet policy goals and prevent the loss of state assets,” said Wang. “We are not a market-based entity that cares only about investment returns.”