China’s booming private equity industry is facing tighter scrutiny from regulators, but investors are still drawn to its higher returns and unique sector opportunities, driven by the country’s new economy.

Chinese regulator the China Securities Regulatory Commission (CSRC) recently stressed that private equity in China should focus on its original purpose of supporting innovation and startups. CSRC chairman Yi Huiman noted in an August 30 media speech that the regulator will crack down on fake funds that are promoted to the general public, tighten scrutiny of fundraising and probity within private equity (PE) funds, and generally exercise firmer control of the industry.

This type of supervision isn’t new. Last December, CSRC officially released the first regulatory document specifically addressing the supervision of the Chinese private fund industry along with private fund managers. The document aims to reinforce the supervision of private funds and crack down on various forms of non-compliance, while protecting the legal rights and interests of private fund investors and promoting the healthy and disciplined growth of the industry.

At the end of July, China's private equity and venture capital funds managed a total of Rmb12.6 trillion ($1.95 trillion), Bloomberg data shows.

"On a micro level, China's regulatory regimes relating to antitrust and data protection have also been tightened, which will likely have far reaching implications for financial investors and their portfolio companies from a compliance and operational perspective,” said Paul Tang, partner at New York-based law firm White & Case. “PE sponsors have to be extra vigilant to mitigate compliance risks presented by their portfolios."

ALSO READ: Private equity in China faces hurdles despite new rules

Colin Sau, TR Capital

TRUE ADVANTAGE

Higher growth, a better governance structure, and diversification potential are the reasons that investors still favour private equity assets.

“One of the big benefits to private equity is around the governance structure,” Joe Fazzino, executive senior director for pension investments at US-based Raytheon Technologies, shared in Private Assets Investment Week held by AsianInvestor last week (September 13). “For example, an investor in a public stock has very little say in the management of that company. Skilled general partners, however, asserting the control that comes with being a private equity investor, have a say on management decisions, and closer supervision over day-to-day activities. I'm willing to invest in those illiquid structures if it means that my general partners are closer to management,” Fazzino explained.

“If you're looking to be a more growth-oriented investor, then it’s prudent to remain invested in equity markets, without capping upside returns, while riding through investment cycles,” he added.

Fazzino invests on behalf of Raytheon Technologies’ corporate pension plan, which has about $56 billion worth of assets in the pool. The pension plan has invested through many different cycles, with a 7% to 8% allocation to private equity, globally.

Meanwhile, Hong Kong-headquartered PE secondaries investor TR Capital focuses on buying other investors’ shares (secondary directs) and portfolios (fund restructurings). Approximately 60% of its investments are in China, with the balance in India and Southeast Asia. 

"One thing we always ask ourselves is whether the companies that we are investing in are benefiting society as a whole. Great businesses generally have that trait – whether it is through offering a new technology, product, or service,” Colin Sau, managing partner at TR Capital, told AsianInvestor. “This has come to the fore even more in recent months, as Chinese regulators increase their scrutiny on aggressive practices such as anti-competitive behaviour and the exploitation of customers’ personal data."

Joe Fazzino

STAR SECTORS

In China, healthcare and technology still draw the highest attention from investors.

"We only invest in established leaders that are innovative – for example, the ecosystem of companies that would help accelerate the adoption of electric vehicles, as part of China’s goal to reduce carbon emission. Lots of companies are developing ground-breaking technologies in these sectors," Sau noted.

"Similarly, healthcare companies delivering novel drugs or better services to the Chinese population would continue to attract attention from investors. More specifically, the oncology sector has and will continue to be of prime importance to TR Capital. Cybersecurity is also another sector that we are looking into in depth," he added. 

Paul Tang, White & Case

"In healthcare, investors are looking beyond medical devices and increasingly into pharmaceuticals. In hard technology, we are seeing a lot of interest across the full ecosystem of ESG-related sectors (including EVs and batteries). This is in line with the general trend we are seeing from PE investments around the globe," Tang added.

China as a whole accounted for 86% of Asia Pacific IPOs, fueled in part by a number of foreign issuers completing secondary listings in Hong Kong. The majority of IPOs in China were for healthcare and technology companies. PE funds resorted to fewer IPOs for portfolio companies in traditional industries, which led to investors putting more money into healthcare and technology firms in hopes of more promising IPO transition possibilities, data from AVCJ and Bain & Company’s report showed.

Asset managers are also building up their portfolio. Pictet Alternative Advisors closed its debut thematic private equity fund focused on technology at its hard cap of $350 million last week (September 14). Another healthcare-slash-biotech dedicated fund will be launched in early 2022, according to the firm’s statement, although it did not disclose its Asia Pacific breakdown.

“Our allocation to Asia continues to grow, and we’ve also initiated new GP relationships in Asia and expanded on the resource front, so our allocation is likely to further increase in the future. And for our thematic technology program, Asia already accounts for around a third of committed capital (as of June 30, 2021),” according to a firm spokesperson.

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