When assessing the growing universe of alternative investments, it has become more important than ever to acquire a broader global perspective. Private market investments and funds have garnered an incredible amount of attention from institutional investors and family offices, and increasingly these need to be geographically dispersed to leverage differential growth rates across the globe.
China’s explosive growth
While much of the world is experiencing patchy, rocky growth, China’s economy has stood out for its remarkable evolution. Political stability, massive domestic consumption, rapid urbanisation driven by improving infrastructure, and global demand for fast supply chains have made China’s economy appear unstoppable in recent decades. Its GDP growth rate of 6.1% in 2019 was followed by a sharp trough in 2020, and is forecasted to show a strong recovery in 2021 with a predicted rate of 7.9%1.
It is not surprising that the investor community has taken notice of this, channelling funds into
China’s private assets at an unprecedented rate. China’s private debt market is growing, driven in part by investors seeking diversification, but also as a result of its outsized returns compared to other markets. Average IRR for private debt funds in China stood at 11%, significantly higher than Europe’s 7.8% and North America’s 8.2%.
A study by China’s Securities Daily newspaper of private equity investment performance showed a 30% average return on investment (RoI) for 2020. In 2019, China’s private equity market saw deals worth USD 66 billion, bringing total assets under management of the Chinese private equity sector to USD 624 billion.
Poised for further growth
In August 2020, McKinsey reported an average deal size in Chinese private equity transactions of USD 75 million, double the corresponding figure in 2009. This is a noteworthy jump as private equity asset managers are acquiring larger stakes in investee companies, bringing more complexity and potentially more returns to the table.
A further set of tailwinds is fuelling the growth of private debt investing in China including the accelerated need for business expansion, and regulatory influence. Regulators have actively pushed to limit loans channelled via private wealth management firms, microfinance, trust companies and other non-bank participants and this has contributed to the demand for alternative sources of debt.
In turn, the deregulation of offshore lending, for example, means that new sources of credit are becoming available and mutually attractive to all participants. For example, as part of the China-US Phase One trade deal, inked in January 2020, Beijing permitted US financial services players to apply for Asset Management Company licenses to invest in Chinese distressed debt.
The investment opportunities that this creates warrant attention, and a place in a well-constructed portfolio. However, to navigate a complex and emerging system necessitates the right mix of investment strategy and partners.
Trust & credibility are the cornerstone ingredients
Participants in the alternative asset universe are assessed based on their past track record on standout transactions and their existing footprint or deal pipeline. Deal origination, or sourcing of promising opportunities and finding a berth in large transactions, is a function of these factors. As such, the most credible and established players repeatedly find themselves on the right side of networks and other critical information flows in origination.
In line with their counterparts in more developed markets, Chinese private asset managers are increasingly taking hands-on roles in target companies. Investment managers in the more developed markets have shown a strong preference towards this approach to investing, where they use their controlling interest in the asset to influence decisions and maximise RoI. This entails partners gaining seats on the board of management and influencing how their businesses are managed.
In a private credit scenario, an on the ground presence and deep networks also help to identify and assess good quality collateral. In addition, special situations scenarios need regular and in-depth analysis, monitoring and setting of the most relevant covenants in order to balance risk and return.
The skills required for venture building in the Chinese context is unique, given the scale and complexity of businesses, the differential rates of digitisation and adoption of technology, and the talent management landscape in China.
In addition, trust and credibility are critical factors that help bring acquisitions and investments to fruitful exits. Typically, private equity exits are via Initial Public Offering (IPO) or via a corporate sale. Private debt exits can be equally reliant on capital markets, secondary sale and also include refinancing. All such avenues rely heavily on local expertise in setting of terms, and strong networks to structure successful exits, especially in a post-Covid era where ability to conduct in-depth due diligence is limited.
The arena is a complex ecosystem
Blockbuster-sized private fundraises often require multiple participants to come together for a single transaction. Amid intense competition for deals and significant sums of money chasing fewer attractive assets, asset managers need to cooperate on deal flow and origination. This also brings significant advantages to the deal in the form of business synergies, networks, and human capital.
The Chinese domestic economy is a fragmented albeit rapidly growing one, with differential rates of development and technology adoption. Investee companies might range from cutting-edge technology start-ups to large-scale consumer businesses, and include traditionally managed family firms. Therefore, the role of China’s venture capitalists is more complex than in a more uniform market, as it requires specific wide-ranging knowledge and expertise across origination, execution, and exit.
Talent is essential
For the above reasons, talent in China’s private asset investment sector needs to encompass a broader range of skill sets and capabilities than ever before. As deals become more complex with respect to technology, business scale, size, and market dynamics, greater expertise and experience are needed to navigate their intricacies.
Especially for the value creation and venture building aspects of business, the asset manager’s ability to place candidates on the boards of target companies generates incremental returns. New challenges to business growth, such as technology adoption, security, and legal frameworks, continue to spotlight the importance of talent and relevant skills.
New challenges to business growth, such as technology adoption, security, and legal frameworks, continue to spotlight the importance of talent and relevant skills.
An evolving regulatory environment
Private investment in China falls under the regulatory purview of the China Securities Regulatory Commission (CSRC). In 2020, the CRSC enacted new regulations to protect the various participants in the alternative asset investment sector. This move was fuelled by the sector’s rapid growth, which raised concerns over the legality and compliance of certain aspects of transactions.
However, the Chinese Government has also praised the growth of the private market sector in bringing development and transformation to its corporations. This implies that while this explosive growth is a welcome phenomenon and one that is encouraged – participants must be in compliance with an evolving regulatory landscape.
To wrap it up
Alternative investments have traditionally relied on business connections to drive deal flow. A savvy ear to the ground is perhaps the most valuable asset in deploying capital to the richest pickings, finding the optimal mix of talent, and navigating a unique investment landscape.
Geopolitical tensions, the dynamics of global trade, implications of climate change, and the COVID-19 pandemic have ushered in an era of uncertainty. As such, investment managers are called upon to be more prepared than ever before, as they can no longer simply ride on a growth trend. There is a renewed emphasis on cherry-picking the more promising deals, adding value and engineering well-timed exits.
Lastly, investing in a complex and evolving market like China demands a clear strategy for working alongside key stakeholders – the regulator, fellow participants, investees, and the ecosystem as a whole.
LU Global is a wholly owned subsidiary of Ping An Group and Lufax, two of the most prominent financial services institutions in China. With our Chinese roots and international presence we are able to bring deep expertise and experience to investing in Chinese alternative assets. We partner with China’s leading private equity asset management companies as well as global private equity experts to deliver bespoke and flexible investment options for family offices and asset management companies throughout Southeast Asia.
For details on our private market fund, please contact Larry Ong at [email protected]