Will PE still flourish as China turns inward?

With the end of China’s 20th Communist Party Congress in Beijing, there are signs that a more insular country is emerging—it’s a worrying development for private equity, an asset class that thrives on international cooperation.

Chinese premier Xi Jinping used the event to confirm his unprecedented third term. He has used his power to expand state control of the economy and crack down heavily on parts of the country’s giant tech sector. He has also, it appears, begun to turn his country inward, emphasizing economic self-reliance and asserting China’s national interests on the global stage.

At the same time, the influence and power of China’s private sector has declined. According to reports, significantly fewer executives from private groups were invited to this month’s congress compared to previous years.

These are unstable times for China. The unraveling of the country’s real estate sector has triggered a financial crisis years in the making. Meanwhile, a zealous commitment to its zero-COVID policy, enforced by regional lockdowns and travel bans, has been ruinous for the country’s fortunes. This month, the International Monetary Fund downgraded China’s growth forecast for next year to 4.4%. There is no indication that China will loosen the policy.

During this turbulent time, there are signs that PE’s love affair with China may be waning. Both deals and fundraising activity have fallen from recent peaks—the country that is the jewel in Asia’s PE crown has lost some of its sparkle. China will still play a big role in the future of private equity in the region but the nature of that role, and the extent of state’s involvement, may change.
 

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I first started writing about private equity a decade ago, when I lived in Hong Kong, one of China’s two Special Administrative Regions, the other being Macau. At the time, Greater China arguably represented PE’s greatest Asia opportunity with Hong Kong as PE’s international gateway to the nation’s fast-growing economy and one billion customers.

That still holds true today but the city has lost some of its original cache. Like the rest of China, it has suffered the impacts of a punitive lockdown regime and the fallout of a national security law introduced in 2020 that curtails important Hong Kong freedoms. The result is that some investors are looking elsewhere in the region, most notably Singapore.

Among those that remain in Hong Kong, many have expressed dismay at the political climate on the Mainland. Weijian Shan, the head of PAG Group and a figure that looms large in Asia’s PE community, has been a particularly vocal critic. Earlier this year, he was quoted by the Financial Times, saying his firm has to be extremely careful about its portfolio in the country.

This year has so far seen $53.5 billion transacted across 573 deals in the Greater China region, which includes Hong Kong, Macau and Taiwan. At the current pace, the year will fall some way short of the 726 deals, worth $88.6 billion, completed in 2021.

Fundraising has also taken a hit with fewer, albeit larger, funds reaching a close. So far this year, 16 funds in the region have raised $26.2 billion. The biggest among them was Baring Private Equity Asia‘s $11 billion regional fund; the firm was acquired this year by Sweden’s EQT, which already has a presence in Hong Kong. By comparison, 2019 saw 73 funds raise $68.6 billion.

For funds domiciled in China, there is still around $121 billion in dry powder. But not all that capital is necessarily being put to work in China itself since many of these vehicles will have a pan-Asia focus. Some Asia managers are giving mixed reports on how they will handle their China exposure. It was reported by Bloomberg in July that The Carlyle Group would cut its China exposure in its $8.5 billion fund, but the firm also said last month it would be leaning into the country.

Others appear to remain bullish; Temasek-backed firm Vertex was recently reported to be seeking $500 million for a new China-focused vehicle. The buyouts are still happening too. CDH and PAG have been mulling offers for Chinese data center company Vnet Group, a US-listed business.

Yet, while the PE market will endure in China, the state could have great influence. One way this has already materialized is through the growth of government guidance funds. These are public-private investment vehicles that look to further government policy goals, while generating financial return. Such funds now account for a significant chunk of private markets activity. According to figures cited in The Economist that came from Chinese research firm Zero2IPO, around 2000 collectively raised nearly $1 trillion between 2015 and 2021.

For investors, the Chinese economy will always remain too big to ignore, but so will its government. The Chinese private markets industry may continue to play host to the world’s investors, but just like this month’s Communist Party Congress, it will be the government that decides who gets invited.

Featured image by Jenna O’Malley/PitchBook News