Tapping into private markets

China’s quality revolution and the structural changes we see unfolding in the economy have important implications for the fast-growing market for private assets. The dual circulation strategy, a push to become carbon neutral by 2060, and urbanization are long-term transformations that may not, in our view, be fully captured by assets listed and traded on public markets today. Asia-Pacific private capital returns over longer time horizons such as the past five, 10- or 20-years have outpaced those in regional public markets.1 Yet we believe manager selection is key when it comes to private markets. Investors wanting to participate in China’s structural transformations may want to consider doing so via private markets but should be mindful of the risks involved.

Private market investing in emerging economies is not a new concept, yet the risks and uncertainty are higher than in developed economies. Investors in private markets are typically tying up capital for long periods of time. This long investment horizon may leave them vulnerable to changes in rules and regulation that evolve more rapidly in developing economies than they do in developed peers. Local expertise is essential to understanding the nuances, complex structures in place and potential counterparty risks. Maintaining long-term relationships with sponsors, Chinese banks and companies is also key, in our view. Data availability and verification is difficult – a key reason why we do not currently estimate returns for Chinese private market assets as part of our capital market assumptions (CMAs). We believe private markets offer opportunities for investors cognizant of these risks, and we see the asset class as more of an “alpha” story where selectivity will be key rather than a story of “beta,” or broad exposure.

Private market activity in China has been traditionally led by domestic investors. Yet elements of the quality revolution may help change this. We think Chinese authorities see it in the economy’s interests to entice foreign capital to play a bigger role in the development of its onshore financial system. Last year the country’s Qualified Foreign Institutional Investor scheme was changed to open up onshore private funds to foreign investors – one sign that authorities are warming up to foreign capital.

Private credit, real estate and private equity are among the areas we see growing rapidly in China. Stability of the financial system is another core tenet of China’s quality revolution. An important pillar of this objective is a desire among policymakers to crack down on shadow banking while gradually promoting sources of capital outside of the traditional banking system. The chart on the left below compares how non-bank credit as a share of total corporate borrowing in China compared to selected peers as of last year. We believe private lending has an important role to play in plugging the gap created by the retreat of shadow banking. Changes to bankruptcy laws will help create a healthier and deeper credit market, in our view. 

We believe private markets may be better placed to offer targeted exposure to emerging domestic trends in China. A Bain & Company Asia-Pacific private equity survey found investors expect the biggest growth in funding businesses driven by digitization, as shown on the right below. Simple allocations to onshore equity markets mean less exposure to sectors with growth opportunities, underscoring the appeal of tapping private markets. China’s urbanization drive – a major policy initiative – is another example. Urbanization in China still lags behind global peers, yet is growing at a fast clip. A McKinsey study2 showed China’s headed for an urbanization rate of about 58 percent by 2030 – a level well below that of high-income economies, creating opportunities in residential real estate and infrastructure, in our view.

Private Markets

Sources: Blackrock Investment Institute, Bank for International Settlements, Bain & Company, May 2021. Notes: the left chart shows the share of banks and non-banking financial institutions in total corporate lending in China, the euro area as a whole and the U.S. Data is as of September 2020, the latest available from the BIS. The chart on the right shows the sectors in which Asia-Pacific private market investors expect long-term growth according to a Bain & Co 2021 survey