The global Covid-19 outbreak has directed more institutional investor attention towards healthcare-focused private equity funds, particularly those with a China focus.

The deal activity in the healthcare sector has risen over the course of the year as the pandemic has made its effects felt, and private equity funds are attracting more asset owner capital. A Hong Kong-based insurance investment executive told AsianInvestor his firm has invested in “a few” healthcare-focused private equity funds, declining to specify the exact number. He added that investors into such funds can typically expect around 22% of gross returns at the fund level.

But asset owners looking to benefit from such investments will need to consider the hurdles the funds will encounter, including mounting competition for assets raising prices and an increasingly fraught geopolitical environment, said industry experts.

Wei Fu, chief executive officer of Singapore-based private equity firm CBC Group, told AsianInvestor the current macro environment is “not perfect”, but added that he remained positive towards the sector. His confidence particularly stems from the rising affordability of healthcare services and drugs among Chinese consumers and the maturing of China’s healthcare professionals.

One-third of the firm’s $2 billion in assets under management (AUM ) has been sourced from investors based in Asia, including sovereign wealth funds, endowments, corporate pensions and family offices in Singapore, Hong Kong, Japan and Taiwan. A specialist healthcare fund manager, the firm’s portfolio companies are spread across China, Singapore and the US.

Fu said that biotech firms offer particular appeal to private equity funds, due to a rising likelihood that some firms will turn to Hong Kong’s stock exchange and China’s Nasdaq-like Star Board to list and raise capital. However, he admitted that competition in this sector is also heating up, which offer more risk.

“Everyone is fighting to get into the healthcare sector, no matter [whether] it's a generalist fund or a healthcare specialist fund ... so there is too much investors' capital chasing very few good companies,” he said.

Moreover, biotech companies generally take longer to generate profits, as they require stringent approval process and clinical trials, for obvious reasons.

“In biotech, you have to invest a lot before you see the first dollar of revenue or profit...[but] if one of the drugs got approved, then we will have a target sales of at least Rmb1 billion ($141.42 billion) and we could have around 30% to 50% of profit margin,” Fu said, and added that the industry typically has a target return of around 30%. CBC declined to provide its specific target return. 

EMERGING ASIA APPEAL?

Aspiring investors will also need to consider an increasingly unpleasant geopolitical environment as they seek out assets in China.

Close to half of the limited partner respondents to Coller Capital’s global private equity barometer, released on June 15, said political risks across emerging markets in the next five years will increase, and 66% predicted that the China/Hong Kong/Taiwan will see higher levels of such risks.

Healthcare is particularly seen to be at risk. Indeed, several Chinese firms appear to have put their IPO plans on hold due to a proposed legislation by the US to tighten regulations for them to go public in the country, likely dampening private companies’ exit prospects. The US government has also previously said it had become too dependent on China for essential drugs, including antibiotics and vitamin C.

Nonetheless, the potential appeal of such healthcare private equity funds in emerging Asia looks set to draw more investor interest – and capital.

While fundraising overall has largely lagged that of last year, emerging Asia saw the biggest capital influx year-to-date with $15.4 billion raised as of May’s end compared to other emerging markets. The region has also continued to take up the biggest share of aggregate capital raised by emerging markets-focused private funds, according to alternative data specialist Preqin.

Globally, total disclosed healthcare deal value reached $78.9 billion last year, the highest on record, said a report released by Bain & Company on March 8.

The ongoing interest in Asian private equity funds can be explained by the increasingly attractive returns these funds have generated.

The median net IRR [internal rate of return] of emerging Asia-focused private equity funds over the years has been on the rise (see chart below), reaching 17.3% for funds beginning investing in 2017, according to alternative assets data provider Preqin.

Source: Preqin

(Click for full view)

The coming months and years also offer promise for investments into China’s healthcare sector, despite the risks. Fu said noted that China’s participation in the global drug industry will “shift the whole game plan” and offer the biggest growth driver for mainland biotech companies over the long term.

“Previously, 70% of the drugs are developed in the US, 15% in Europe and 15% in Japan. In the future, I think China can account for 30% in terms of global drug innovation,” said the former executive of Singaporean investment company Temasek.

Article updated to clarify the typical target return figure of private equity healthcare funds is 30%, according to CBC Group, and does not represent its internal return goal.