A bet on late mover advantage

I have no doubt that you do your share of reading on China. You must be talking about it plenty, too. In fact, if you’re anything like me, there are probably moments when you feel like you’ve had it with China’s dominance over the economic and financial discourse of our time. “Enough already,” you sometimes want to say. “Can we talk about something else? Please.”

Philip Borel

But the fatigue never lasts, does it? Who can, or wants to, ignore China? Too great is its might, too big the numbers required to measure and describe its influence.

Example: $1 trillion. That’s the amount of direct offshore investment Chinese companies are expected to have made by 2020, according to a recent report by the Asia Society, a think tank. The first $230 billion of this is already in the bag, the report says. But there is vastly more to come. If this forecast is right, then Western markets will get swamped with Chinese capital. (Note to private equity: what an exit opportunity!)

Another example, a bit closer to our asset class: 93 percent. We are now talking about the China portion of all emerging market-focused private equity fundraising in the first quarter of this year. The number, equating to $5.7 billion, was recently quoted by the Emerging Markets Private Equity Association; PEI’s own data suggests the exact figure might be even slightly higher.

It’s a staggering statistic, and also quite a perplexing one if you consider that it usually isn’t just China that gets a mention when investors discuss private equity opportunities in new territories. Has no one been committing to other Asian markets recently? What about India for instance? Or Brazil? Russia? Africa?

Private equity fundraising is of course notoriously lumpy, so maybe this China bias is just an outlier that will self-correct the minute new funds in other markets become available. But there seems little room for doubt as to where the LP herd is grazing at the moment.    

Not everyone thinks this wise. In a recent conversation with a fund of funds manager with offices in Europe and North America, I was told that for them, a presence in Asia let alone China was a ways off. With a successful track record of investing in Western buyout funds, the group hasn’t seen much going on in China that stirred a fear of missing out. Venture, growth capital and PIPEs are still the main strategies, so this manager is content to hang back and wait for a later-stage private capital investment culture to take hold.  

They also take the view that private equity investing in high growth economies does not necessarily translate into superior performance. A bet they made previously on Central and Eastern European private equity in the mid-1990s bore this out, and has not been forgotten. The region’s stock markets boomed, but its private equity funds turned in results that weren’t much to speak of, and hardly sufficient in light of the added risk.

Speaking of risk: to my China sceptics, the perceived prevalence of “pretty odd” risks was perhaps the most significant argument against a move into the Middle Kingdom any time soon.

Indeed, for any limited partner focused on governance and transparency, China can be said to remain an acquired taste. You will recall press reports in May that The Carlyle Group, which has built a large and in many ways impressive platform in the country, is having trouble with two portfolio companies whose stock has been suspended from public trading following accusations of fraudulent activity.

Remember also the case of Wu Ying, the 29-year-old business woman who in April was sentenced to death by a Chinese court for alleged crimes labelled “illegal fundraising” by the authorities. Whatever the ins and outs of Wu’s case, it’s the sort of tale that Western fiduciaries are bound to see as confirmation that if you put your capital into China, then you had better be alive to the possibility of some hair-raising problems surfacing.

The bottom line for the FoF talking to PEI about China was this: one day for sure but, equally emphatically, not now; we need to see some of the quirks being straightened out first.

What makes this stance so interesting is that other leading funds of funds are piling in already, contributing to the aforementioned fundraising frenzy. It’s early versus late mover. Time will tell whose call was right.
In the meantime, expect more talk about China. And also: Keep reading. This epic tale will run and run.