China attracts the biggest share of investment flows into emerging market private equity, and that looks set to continue as its PE market evolves, given the level of interest from asset owners, both foreign and domestic

The list of institutions keen to their build mainland PE exposure includes Canada’s Ontario Teachers’ Pension Plan (OTPP), Shanghai-based China Pacific Insurance Company (CPIC) and Alaska’s sovereign wealth fund.

Investors view the market as a nascent, long-term opportunity, despite issues such as China’s slowing economy, months of protests in Hong Kong and Beijing’s trade spat with the US. That’s not to mention the coronavirus. While Chinese data indicates that the situation has stabilised domestically, the outbreak has, as of yesterday (March 9), fuelled a deepening rout in global markets.

There are a number of reasons for the generally positive outlook and various approaches that asset owners are taking to China's private equity market.

Ben Chan, OTPP

Ben Chan, OTPP’s Asia head, anticipates more private equity opportunities in Asia – and particularly China – as the market evolves. Whereas China, for instance, has been characterised by a lot of growth capital deals in the past decade, he said, in the next five to 10 years there will be more control buyouts and takeovers in the region.

More people are willing to sell majority stakes now, Chan added, and that trend is likely to continue. This is driven by various reasons, he explained, such as changes in the economic structure in places like China and India.

There is consolidation to come across large economies such as China, as it transitions to a more consumer-driven (rather than state investment-driven) economy and increasingly opens it up to foreign capital.

Another factor that will lead to opportunities is the forthcoming big transfer of assets to the next generation after the huge expansion of regional wealth – particularly in China – in the past three decades, Chan said.

As a result of such developments, he added: “We see our partners in Asia switching from growth capital mode to doing more buyout and control deals. That requires some retooling of the skills and the people and mindset. Some funds will do a better job than others of managing this transition.”

Be this as it may, but does it concern Chan that the huge inflow of capital into private equity is compressing margins?

OTPP has always been, and will remain, selective about its PE investments, he said. “You’ll find we’ll probably only do a handful of bigger-scale deals in a year. And we’ll look to scale those up through repeat business with the same partners.”

TRUSTED PARTNERS

So will the pension fund – which is also planning to make its first property investments and expand its infrastructure portfolio in Asia this year in a drive to treble its regional allocation – seek more asset management partners as it builds its regional exposure?

“I don’t think we’re reducing the list, but we’re going to be selective about expanding it,” Chan said. “That has always been our belief. We would rather go very deep with fewer trusted partners and do larger deals together.”

He cited the agreement to buy up to 35% of Dream Cruises from Genting Hong Kong last year alongside long-standing partner TPG, and the transactions for Australian education provider Navitas and New Zealand-listed dental provider Abano Healthcare done with BGH Capital.

Chan told AsianInvestor in 2018 that OTPP might have two strategic partners in each of its six focus markets in Asia Pacific (Australia, China, India, Indonesia, the Philippines and Vietnam).

OTPP would also consider co-investing alongside other asset owners, but has not yet done so in Asia. “We are open to this type of transaction if it is with the right partner and in the right sector,” he said. 

Ben Deng, CPIC

CPIC, too, is building its exposure to Chinese private equity. “We think PE is still going to perform better than other asset classes in relative terms,” said chief investment officer Benjamin Deng.

China’s private equity market is undergoing structural changes, he explained. “With new IPO rules coming into force on March 1 [last year] for the science and technology board, my thinking is that China is still in the very early stages of having a mature and growing PE sector.

“Which means we’re going to see higher-quality companies being funded through the PE market before they get listed,” Deng said. “So I forecast that Chinese private equity investments will still generate a few hundred basis points of return over that of public equities.”

CPIC’s 'other equity investments' portfolio – comprising mainly private equity – stood at about Rmb63 billion ($9.1 billion) as of September 30, up from Rmb55.4 billion at end-2018. The plan, as Deng told AsianInvestor early last year, is to raise its allocation from a low-single-digit percentage to a mid-single-digit percentage of its Rmb1.37 trillion in investment assets.

Meanwhile, the Alaska Permanent Fund, a $67 billion sovereign wealth fund, is building its exposure to Asia through private equity above all, with China accounting for most of its non-US PE assets. Its CIO, Marcus Frampton, sees equity as the best way to access emerging market growth, and private equity in particular as often the best way to get exposure to EM consumer and tech companies.

The range of macroeconomic concerns besetting China would appear a short-term blip for such asset owners. OTPP’s Chan arguably sums up the view of many: “We are a lot more long-term than the average investor. Geopolitical issues come and go; we consider them, but do they make us majorly change our asset allocation? Not really.”