Side Letter: China PE’s returns rethink; secondaries deal deferrals; healthcare’s hype

LPs want more bang for their buck when backing Chinese managers. Plus: Secondaries buyers are using deferrals to bridge the gulf in pricing expectations; and RiverGlade rides the healthcare wave. Here's today's brief, for our valued subscribers only.

Just happened

The secondaries panel at Wednesday’s HKVCA China Private Equity Summit

Summit you should know about China
Side Letter was privy to a rather unfamiliar sight in Hong Kong this morning – a conference room packed to the rafters with private equity professionals. Industry participants convened on Wednesday for the Hong Kong Venture Capital and Private Equity Association’s 21st annual China Private Equity Summit. Such gatherings have been something of a rarity in the past couple of years, with Hong Kong slower to relax quarantine and social distancing measures than some of its international peers. Topics du jour spanned US-Sino relations, regulatory change, SPACs, climate tech, secondaries and more.

One question on everyone’s lips was whether LPs’ appetite for China has been impacted by recent events, including regulatory change and pandemic disruption. Though the consensus was that allocations to China haven’t been radically altered, return expectations for LPs committing to Chinese funds have increased in response to additional uncertainty. “Given what’s happening right now, we do expect to put up a higher bar in terms of return threshold for Chinese investments,” said Michael Lam, managing principal at Chow Tai Fook Enterprises, the family office arm of Hong Kong’s Chow Tai Fook Jewellery Group.

Yan Yang, managing director at BlackRock PEP, was of a similar mind: “I think in the last two years, quite naturally, when you underwrite your investment, there’s additional scrutiny that needs to be put in place,” he said. “It’s not like a top down limit or anything, like you should reduce your allocation or anything, but it’s just from a return perspective, you do have more factors it needs to budget in.” Here are some additional highlights:

  • Stay in your lane: LPs want GPs to resist the urge to pivot to new sectors, strategies or markets in response to last year’s regulatory crackdown. More on that in today’s coverage here.
  • Secondaries sectors: RMB to USD restructurings are now more likely to be found in a small handful of sectors that are more open to overseas investors. “For new energy and for semiconductors, because the domestic market is hot… they don’t need to build up the USD track record,” said Colin Sau, managing partner at Hong Kong’s TR Capital. “But…for all the sectors like SAAS, enterprise solutions, healthcare, they can still win the USD investors’ appetite and the IPO potential in overseas market is higher, so they want to build up this track record.”

Delayed gratification
LP fund stake sales were worth $28 billion in the first half of this year, equivalent to 53 percent of total secondaries market volume, according to Campbell Lutyens. This was driven by public pension funds, which accounted for 48 percent of portfolio deals versus 10 percent in the same period of last year.

LPs looking to sell down parts of their portfolios have encountered an increasingly dislocated secondaries market. Buyers have been expecting pricing to reflect the decline in stocks, while many LPs have refrained from selling portfolios until this decline is reflected in the valuations set by sponsors, which tend to lag by a couple of quarters.

This has led to an increasingly aggressive use of deferrals – which allow buyers to pay a higher price in exchange for payment in instalments – to bridge the gap in pricing expectations, our colleagues at Secondaries Investor reported this week (registration required). Of the 29 percent of sellers who used deferrals, more than eight in 10 LPs deferred more than 60 percent of the purchase price and 68 percent deferred for 18 months or longer.

To many, $1 today is worth more than $1.10 or so in a year’s time. Campbell Lutyens’ findings show that just under one third of LP sellers would prefer the inverse.


APAC outflows
We’ve heard from Hong Kong this morning. What about the rest of Asia-Pacific? PE has experienced significant outflows among regional LPs over the past six months, according to an AsianInvestor survey taken between April and May this yearThe asset class, which represented 4.9 percent of asset owner portfolios as of October, fell to just 2.6 percent as of May. Investor allocations for private debt, meanwhile, saw the largest increase (to 6.3 percent from 3 percent) which may be in response to interest rate hikes, while real estate was the most popular alternative asset class at 7.1 percent. Alternatives allocations more broadly rose from 15.3 percent to 21.5 percent over the period.

A sector in good health
Healthcare-focused RiverGlade Capital has closed its latest flagship fund above target on $453 million, per a statement. This marks a step up for RiverGlade Capital II, which closed 17 percent above target and north of its undisclosed initial cap. Its predecessor closed in 2019 on $325 million.

With healthcare becoming a natural area for attention – and therefore investment – during the worst of the pandemic, GPs have been dogged in their search for value-creation opportunities. A report from Bain & Company found that total disclosed deal value in the sector more than doubled to hit $151 billion globally in 2021, more than double the amount in the previous year, with the number of healthcare-related deals increasing by 36 percent. Dive into the factors behind this capital injection in Private Equity International‘s recent Healthcare Report.

Today’s letter was prepared by Alex Lynn with Rod James and Helen de Beer.