China special: The new breed of LP

China’s soaring wealth is spawning a whole new class of limited partners with an appetite for private equity. Wealth managers such as CreditEase Wealth Management and Noah Holdings have grown rapidly as China surges up the global super-rich rankings.

By 2020, China’s wealthy are expected to have up to 200 trillion yuan ($29 trillion; €27 trillion) to invest. That would make it the biggest high-net-worth market in the world, with 3.88 million high-net-worth individuals, up from 2.07 million in 2015.

This is reflected in the rise of Credit-Ease, which started out in 2006 as a peer-to-peer lender offering loans to millions of underserved Chinese including micro-entrepreneurs, salaried workers and students.

Five years later, CreditEase expanded to wealth management, this time catering to the needs of China’s wealthier classes. It manages over 10 billion yuan of assets for Chinese high-net-worth individuals. Investments span a range of fast-growing industries, from telecommunications to healthcare, consumer discretionary, clean tech and media in Asia, North America and Europe.

Its funds include a fintech investment fund targeting $1 billion and a $150 million global real estate fund. It also has a 2016-vintage Global Private Equity Fund that aims to raise $200 million. The fund caught the attention of the wider markets when reports came out that CreditEase partnered with private equity giants KKR and Blackstone for the fund.

Another big investor in private equity is $50 billion Noah Holdings, which boasts over 135,000 clients and 1,169 relationship managers across 71 cities in China. As of December 2016, private equity accounted for 34.2 percent of its overall portfolio.

Noah has its own alternatives arm called Gopher Asset Management, managing about $17 billion across private equity, real estate, secondary market and other investments in both yuan and foreign currencies. The firm has backed well-established names in venture capital, including Sequoia Capital, Qiming Venture Partners and Horizon Capital.

Both CreditEase and Gopher have an appetite for overseas investments. In recent years, CreditEase has expanded into Hong Kong, Singapore, New York and Tel Aviv. Gopher last year became the first Chinese wealth manager to open a Silicon Valley office as it looks to increase its US venture investments.

“What we are clearly recommending to our high-net-worth clients in China is more global allocation,” says Noah’s chief investment officer PV Wang. “And US venture capital is an area we find very promising given all the technological disruption and push for creativity happening in that market.”

CreditEase is not far behind. The firm partnered with US-based Wellington Management to invest in pre-IPO stage companies and has backed US fintech companies such as Trumid and WeConvene. According to Seungha Ku, partner for offshore private equity at CreditEase, the firm is evaluating opportunities in the venture capital space, largely in the US and China and more selectively in Europe.

“While we remain cautious about rising valuations in growth/late-stage deals, we target new VC investments with proven business models and clear monetisation strategies,” Ku says.

CreditEase Wealth Management’s Seungha Ku, partner for offshore private equity, and Cally Liao, managing partner of funds of funds for private equity, tell PEI where they are finding opportunities to invest

How has CreditEase developed from a P2P platform to a wealth management business backing global private equity and venture capital firms?

Cally Liao: Our business has developed mainly in response to the needs of our clients. We have over 100,000 wealth management clients and most of them changed their mindsets to increase their asset allocation to alternative investments. Chinese investors used to over-allocate to fixed income and real estate because the market was dominated by money managers who offered these types of investment products.

Seungha Ku: Over the years, CreditEase has built up its investment and asset allocation capabilities in alternatives. We are a market leader in China in terms of providing alternative solutions to investors. Chinese investors used to have very limited access to this asset class for two reasons: state-owned enterprises are not properly set up to offer alternative products and there’s still a limited number of experienced private wealth managers.

What’s driving the change in mindset?
CL: One is the significant increase in the investable amount in Chinese households. Another is the lower returns in fixed income coupled with the uncertainty in the domestic real estate market. Third, in the past few years, clients have seen the increased volatility in the capital markets and realised that it would be very difficult to put all their assets in one basket or for them to manage their assets themselves. Lastly, there’s also been a huge increase in individual assets.

Where are you finding the best investment opportunities?
SK: Outside China we mainly focus on North America and are selective in Asia and Europe especially post-Brexit vote and with the uncertainty of certain markets there. The US accounts for more than 50 percent of our global private equity fund of funds, while the balance is a mix of Asia and Europe. We are interested in pan-regional funds in Asia because these vehicles can capture key markets like China and Indonesia. As for Europe, we find developed economies such as the UK, Germany and the Nordic region provide promising investment opportunities.

We think there are a lot of great companies, especially in the mid-market segment where valuations and leverage ratios remain more reasonable compared with large-cap transactions.

What’s your view on the private credit and NPL markets?
SK: We are thinking of preparing a private credit vehicle. As you know, banks are cleaning up their balance sheets as a result of regulation tightening in the US as per the Volcker Rule, which has created a huge missed opportunity. We plan to focus on funds that lend to strong businesses that have positive cashflow but are unable to access bank lending. We see interesting opportunities in Europe and the US.

Despite the volatilities, Europe presents compelling private debt opportunities as the companies in the region have historically relied heavily on bank loans compared with their US counterparts which have access to banks as well as the capital market for financing.

On the distressed and NPL market, we are a lot more cautious. We are in a credit boom cycle now so banks are tightening their lending and similarly financial institutions are lending less and less. When the economy is slowing down, there might be a lot more opportunities and deals in this space as a result of companies failing to refinance their debt packages. We are more cautious about distressed opportunities globally. That is not our focus right now.

What do you look for in fund managers?
SK: We look at the team dynamic among partners. We also look at their investment strategy to see if it makes sense in the next three to five years. We check their track record – both good and bad deals – as well as the industry and partners they selected. We also zoom into their investment process: is it an institutionalised platform or a one-man shop? Lastly, we monitor closely our existing funds through regular and ad-hoc meetings/calls and conferences.