Published: December 20, 2009 on Financial Times fund management

Talking head: Opportunity lies east

By Bruno Raschle

One of the consequences of the global downturn has been a financial power shift from west to east, away from Europe and the US, towards Asia, in particular China.

Western economies have no capital reserves, balance sheets that need restructuring and no outlook for income in the short term. The lack of available credit means financing for any kind of business is scarce and, as a consequence, the west’s ability to continue to finance innovation at pre-credit crunch levels is suffering.

China, on the other hand, has seen a significant increase in the availability of credit financing for small and medium enterprises. New lending in China in June reached $224bn (£138bn, €154bn), bringing total lending in the first half of the year to more than $1,000bn, far outstripping the $717bn issued in all of last year.

This is partly due to the decisive stimulus packages the Chinese government put in place earlier this year, but also a continuation of the fiscal and monetary policies that have driven the transition of China’s economy over the past 15 years.

This west-to-east power shift has opened up an array of opportunities for institutional investors looking to build exposure to Asia, and specifically China. Investing in China, however, comes with a unique set of challenges.
One of the biggest is an unwillingness to accept the different “rules of engagement” – cultural, political or financial. Investors must be prepared to understand differences, and accept them.

For institutional investors able to see beyond this barrier, China’s investment proposition is clear, but knowing how best to access the opportunities is often less so. China’s public equity market has never been readily accessible to foreign investors, and still only a small percentage – less than 6 per cent of public stock – can be purchased by non-Chinese investors, while foreign ownership of Chinese companies remains at a low level.

There is another way. Through private equity foreign investors can participate in a broad cross section of Chinese equity, often at lower entry prices than public equity. This has driven the rapid development of the Chinese private equity market. The number of institutional quality private equity funds operating in the region has increased significantly, from barely a dozen 10 years ago to more than 50 today, and ongoing changes to the regulatory landscape have continued to make the asset class more accessible to outsiders. In addition, many of the products and business strategies being developed in China address consumer markets that are an order of magnitude larger than in the US or Europe, providing entrepreneurs, fund managers and investors with a more favourable risk/return profile than in western markets.

China’s strategy of using private equity to spearhead its economic development has worked well so far – attracting foreign direct investment into the country on a horizon-limited basis, while at the same time allowing the domestic private equity market to develop.

However, this rapid growth is as much a challenge as it is an opportunity for institutional investors. Private equity is more than ever a long-term game and holding periods are increasing. In the context of an environment of continuous and rapid change, manager selection and portfolio construction becomes more demanding.

Non-Chinese investors’ ability to evaluate the skill, experience and mindset of managers, and to identify best-in-class funds, requires a greater level of knowledge and market insight than in the western world.

Ultimately, investors who try to operate at arms length and are not strongly tied into the driving forces in the local political or business community cannot expect to fully understand the Chinese economy and will find it difficult to succeed.

Investors who believe in dynamic asset management and active management of their investments will find in China a welcoming environment for private equity investing.

Bruno Raschle is chief executive of Adveq, a private equity fund of funds