In many respects, private equity in China looks very promising for institutional investors.
First, it requires asset owners to hand over their money for substantial periods of time to reap the rewards of investing into private companies. While that confers illiquidity risk – i.e. it’s hard to get that money back in case of emergencies – the extended investment period can be seen as a good thing. It essentially helps the asset owners lengthen portfolio duration, a constant headache in a country where long-term liquid assets are hard to come by.
In addition, the Chinese government is encouraging institutional investors to invest into private companies as the trade war between the US and China drags on the country’s economic growth.
This combination of factors helps explain why local institutional investors, and particularly domestic insurance companies, are looking to build exposure to private equity – with several beefing up in-house teams to do so. Their interest comes despite a drop in private equity deals this year amid trade war concerns.
But the desire to add to private equity is not free of cost or risk. Would-be investors need to consider mounting investment risks, the possibility of private equity facing increased capital charges, the unproven fund investment capabilities.
Still, some of the country’s largest players appear willing to stomach the risks.
“This is a long-term business. If we do the research right and if we can manage the business right, the alpha [from private equity] is pretty significant,” Benjamin Deng, group chief investment officer of China Pacific Insurance Company (CPIC), told AsianInvestor.
The desire of China’s life insurers to invest in private equity players is marked, when compared to asset owners such as banks, pension funds and sovereign wealth funds.
Insurers first set up internal private equity funds in 2015. In the four years since they have consistently added to their private equity fund investment teams. As of January 2019, insurance institutions were responsible for having established 19 private equity funds, worth a combined Rmb131.31 billion ($19 billion), said Liu Chuankui, deputy secretary general of the Insurance Asset Management Association of China (IAMAC), a self-regulatory body of insurers’ asset management subsidiaries.
He said private equity was playing a greater role in insurers’ alternative investment allocations, in part because it can help them optimise their asset allocation structure and balance their sources of investment yield.
Today insurers are bit-players when it comes to private equity. They were responsible for just 3% of Chinese domestic private equity funding last year, according to a report by consultancy firm Promise Advisors released in February. Corporates were responsible for 38%, while banks provided 34%.
That dynamic is likely to change. The unified set of asset management rules jointly released by the People’s Bank of China, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission and State Administration of Foreign Exchange last year has caused banks to provide much less funding, and made insurers a more suitable source of investment for private equity players, Deng said.
Simmons & Simmons
The new regulation, which regulates all types of asset management products issued by the country’s various financial institutions, prohibited “cash pooling” activities, which greatly diminished banks as sources of capital, Melody Yang, a partner at law firm Simmons & Simmons, told AsianInvestor.
Cash pooling refers to the banks placing capital from different sources into one pot, which is then invested together. The regulators aimed to stamp this out because it was creating an asset-liability mismatch, which happened when banks sourced much of the capital by offering highly liquid wealth management products, and then investing the money in fixed income and sometimes risky and illiquid assets.
The new rules also restricted the multiple layering of products, largely to limit banks’ ability to structure these wealth management products. Most importantly, it banned implicit guarantees on asset management products, including private equity funds. Those limitations have made it far less attractive for banks to invest in the funds, Yang said.
Private equity players have a limited ability to replace bank funding with money from pensions, because China’s retirement industry is so nascent. The country’s combined pension assets are worth about 10% of its gross domestic product, versus 60% in developed countries, according to the Promise Advisors report.
Moreover, local governments don’t have proficient investment capabilities, provincial pension funds place very little into private equity, and enterprise annuity funds are not allowed to invest in the asset class, Promise Advisors said.
So the private equity firms have turned to insurers. And some of these asset owners have begun to increase their allocation to these players, albeit from a low base.
“For the last 15 years real estate has been the main alternative investment asset in China. Going forward, [private equity] should be the most important asset that can generate alpha”, the Shanghai-based chief investment officer of a joint-venture insurer, told AsianInvestor on condition of anonymity.
In overseas markets, private equity investments often offer a net investment return of about 13% over the long term. The potential return in China could be even higher than this level, given the government’s efforts to restructure its economy and drive its growth through technology and consumption. Private equity assets are most relevant to this macroeconomic direction, the CIO said.
Plus, private equity investments can help insurers to lengthen asset duration, pointed out Hoi Tung, co-chief investment officer of Ping An Insurance Group.
Tung told AsianInvestor that Ping An aims to increase its pool of international investments via its Hong Kong-based overseas investment platform from under $20 billion to at least $50 billion within five years. By then, more than 60% of Ping An Insurance Overseas’ AUM will be invested in global alternatives.
Building more long-term international investments should help the parent insurer to lengthen asset duration, he said.
Meanwhile, rival CPIC Life has pledged to increase the private equity share of its Rmb1 trillion investment portfolio to a “near mid-single digit” percentage from a current “low-single digit” percentage, according to Deng.
“We’ll make direct [private equity] investments as well as work with external managers,” he told AsianInvestor in an interview in February. “We hope to strengthen the investment by finding more investment targets, further enhancing post-investment management and exiting strategies, and working more closely with professional [private equity] managers.”
That level would be fairly consistent with the insurance industry in China. In 2019 IAMAC conducted a survey of 190 local insurers (including life, property and reinsurance business), which revealed that an average of 5.7% of their investment assets was allocated to private equity in late 2018. All-told, Chinese insurers had Rmb16.41 trillion in total investment assets as of December 2018, so they collectively held about Rmb935.37 billion in private equity.
Regulators are encouraging insurers to invest in the real economy and private equity investments are a useful means of doing so. Insurers can access such promising industries as technology, medical, education and elderly care. Many unlisted companies in these industries have great potential, Deng said.
Accordingly, in January the CBIRC simplified the registration process for equity investment plans and private equity funds issued by insurers’ asset-management arms with immediate effect. In a consultation paper in November last year, the regulator said it wanted to allow insurers to invest in the equity of private companies across most industries except those on a “negative list”.
Private equity looks well set for an insurance-driven boost in China, but it's unlikely to be plain-sailing, as a follow-up article will outline.
This story was adapted from a feature that originally appeared in AsianInvestor's Summer 2019 edition.
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