CHINESE DAWN

At a recent European private equity gathering in Paris, all the talk during the coffee breaks was centred on how to exploit investment opportunities in one rapidly emerging and still under-exploited market: China was on everyone's lips. And I mean everyone's. Even the French manager of a local venture capital fund investing French family money in small domestic businesses – even he wanted to know about how to best invest in China.

Private equity investors already active in the country can provide some interesting insight into why this is should be so. Take the Hong Kong-based Asian division of international growth investor Baring Private Equity Partners (BPEP) for instance: the firm has invested in 12 Chinese businesses since launching its first Asia fund in 1998. Of these, six have achieved exits, delivering a combined internal rate of return of 105 percent. Two have floated on the Hong Kong Stock Exchange, a bourse where awareness of, and interest in, Chinese companies is naturally high.

Jean Salata, head of BPEP's Asian operations, has been jet hopping round the world drumming up interest in a new fund expected to raise up to $400 million(€319 million) for the region. (The firm's two previous Asian funds raised $600 million in total.) He is keen to persuade investors of the fund's proposed strategy to commit 40 to 50 percent of total capital raised to the Chinese market.

Salata's arguments are based on the idea that there is a significant opportunity to provide growth and expansion capital to China's small and medium-sized enterprises. Many of these SMEs are starved of cash. Around half of China's businesses are in private hands, providing much of the fuel needed to fire the country's economic growth, which was an impressive 9.1 percent in 2003.

But the country's legacy of suspicion towards private enterprise means that many Chinese banks, encouraged by government officials, continue to turn a blind eye to the private sector and concentrate on funding state-owned enterprises instead. As a result, privately owned companies are forced to lead a hand-to-mouth existence, at times having to rely on handouts from friends and relatives, or even loans from black-market financiers charging punitive interest rates.

Practitioners with local knowledge maintain that the companies stuck in this funding gap are not only numerous, but also of high quality. Their managers are often said to have a great deal of financial discipline: because of the shortages of funding, Chinese managers know how to stretch their Yuans (the Chinese currency). They are also considered hard working and entrepreneurial, which is how they came to play a key role part in making China the world's leading exporter of goods.

Another attraction is the fact that Chinese growth businesses don't necessarily have to do much growing outside their home market in order to succeed. With a population of 1.3 billion, China has the world's largest consumer market. (Former BPEP portfolio company Newpalm, a provider of short messaging services (SMS) which was sold to a trade buyer last year, operates in a domestic market with a staggering 250 million cell phone users.) This appeals to investors looking for genuine geographic diversification, because the businesses they back in China can succeed without having to make it in overseas consumer markets in Europe or the US.

All of which means that when fundraisers targeting China hit the fundraising trail, investors tend to listen carefully. Salata says he is already seeing growing interest from the US for instance.

China is obviously not without its potential pitfalls. Transparency is an issue, as evidenced recently when a number of cases of dubious bookkeeping practices came to light. Chinese managers are not used to accepting influence from outsiders and may resent having to relinquish control. And asset prices could be overheating if there is too much expectation. But these are all familiar characteristics of many emerging markets and will do little to dissuade foreign investors from considering ways of gaining entry.