Decelerating growth and ongoing trade disputes with the US mean that private equity investors have been watching China closely over the last year.
As Private Equity International noted last week, fundraising is expected to soften this year and more mid-market buyouts will emerge as generational succession among companies takes root.
We caught up with Andy Wang, a Beijing-based partner with Chicago-based private markets manager Adams Street Partners, which has been investing in China since 2005, to discuss how geopolitics has affected investor interest, why it’s still a good time to invest in China and the firm’s near-term priorities in Asia.
How has LPs’ appetite for China funds changed amid the geopolitical situation between China and the US?
Macro factors, including geopolitics, impact investor appetite. At the same time, we still see good demand from LPs for China funds for a few reasons. First, private equity as a long-term asset class is less correlated to macro volatility. Good PE managers also have more levers to create value and generate excess returns. Also, the China market still has compelling investment opportunities, given its relatively good growth (despite coming down), the structural shift to innovation and quality, its big domestic market, deepening talent pool and a complete manufacturing supply chain.
What’s more, now is an interesting time to invest in China funds. We have seen private deal valuation become more reasonable, after a material public market correction and reduced capital supply for PE fundraising. The GP landscape is going through some shake-up, and managers are pushed to become more professionalised. As a result, high-quality China funds are still sought after, and a few managers that we recently invested in were oversubscribed.
Which parts of the China market would you expect to deepen given the macro and political situation we have now?
We have seen more spin-out managers and newly formed GPs in recent years. When the macro economy is not so favourable, it would be tougher to raise a first-time fund. But strong teams should be able to stand out and get funded.
In terms of strategy, we expect buyout deals and buyout managers to continue to increase. Lower growth rates, more complex operational challenges, generational succession, and multinational companies’ strategic rationalisation in China all present buyout opportunities. However, control buyout transactions require managers to have much stronger operational capabilities, and this would become one differentiating factor for GPs if done well. We also expect professionalisation and sector expertise to go on, as well as the emergence of more sector-dedicated funds. Lastly, we expect the venture space to deepen as strategies become more targeted.
Are you building out any other part of your business in Asia to mitigate the expected slowdown in China?
Despite the macro slowdown, our China fund portfolio has been holding up very well, as we have selected managers that select underlying companies well. Our exposure is overweight in defensive, domestic and growth-oriented sectors like healthcare, consumer, IT and services.
On the primary fund investment side, we have a good portfolio and strong GP network in Asia, which helps balance and diversify the risk in China. On the co-investment side, we have become more active in both China and the region, in order to capture the opportunities in a lower valuation environment. On the secondaries side, our team has been actively evaluating opportunities and options to aide our portfolio.
How do you expect 2019-vintage funds to perform?
We focus on long-term returns across cycles and generally diversify across vintages for our clients. We are optimistic of the expected performance of 2019-vintage funds in China.
The overall competition environment and valuation level has become more reasonable. Fundraising in China has come down materially. A tougher market environment should also push businesses, as well as fund managers, to differentiate and compete on quality.
A word of caution is that manager selection and access might become more challenging, as return dispersion could increase going forward.
Andy Wang is a Beijing-based partner at Adams Street Partners and supports the firm’s primary investment team.