Friday Letter Selling China’s macro dream alone is not enough

Of more than a thousand managers active in China to choose from, one experienced LP estimates there are fewer than a dozen genuinely worthy of a commitment. GPs looking for funding will need to do more to point to China’s growth story.   

An anecdote from Xiang-Dong Yang, managing director of Carlyle Asia Partners, serves to illustrate the proliferation of managers now dabbling in private equity in China. “Two private equity executives [are] talking in a Beijing taxi,” he told delegates at the HKVCA Asia Private Equity Forum, “when the taxi driver turns around and says, ‘You’re in private equity? I’m also doing some private equity investing.’”

When even the taxi drivers are claiming to be involved in private equity, you have a problem. Picking through the multitude of firms active in the country’s private capital market is an enormous challenge, not least because China remains a relatively young market and track records are shallow or non-existent in many cases.

The reasons for this proliferation are obvious. Everyone wants a piece of China’s remarkable growth story. At a time when most Western nations are seeing GDP contract or stagnate, China’s grew by more than 9 percent last year. Trade volume rose by more than 20 percent to $3.6 trillion. More than half the population now lives in urban areas for the first time in the country’s 5,000-year history.

Managers who use this macro story as part of their pitch are likely to be ploughing a fruitless furrow however. Everyone (cab drivers included) is already sold on the growth story, and from an investor’s perspective, there are cheaper and easier ways to piggy-back onto that trend. The truly successful GPs deliver something else – an ability to sift through the cornucopia of investment opportunities, pluck out the most choice, and then burnish the gems they uncover.

Doug Coulter, head of LGT Capital Partners’ Asia-Pacific private equity unit, rejects the use of the macro argument when managers pitch funds to him. “We meet about 600 GPs a year with the majority of those being Chinese. The days of selling the China dream are over. For a manager at this point in time to go to the West and talk about the urbanisation and the rise of the Chinese consumer, I mean, it’s a joke, right? Every single GP that walks into our office says the same thing. Just because these ‘mega-trends’ are happening, [it] doesn’t mean that you can make money off them. You want to be part of those trends, but not everyone is going to have a 5x fund.”

Finding those capable of delivering alpha in a complex, and vast, market like China is going to be one of the key challenges for LPs over the next few years. But channelling the capital inflows appropriately will take patience and circumspection from investors.

It’s beyond doubt that China will only grow more important as a private equity market. Within a decade, it could well be on a par with Europe and North America. But unravelling its complexities and sifting through the ever-increasing herd of managers to find the true thoroughbreds will take patience and great diligence. ‘Move in haste, repent at leisure’ seems an apt maxim.

For in-depth analysis of the Chinese private equity market, read PEI’s China Handbook 2012, published next week alongside our June issue.