Private market opportunities in China

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Risk: Investments in China are subject to certain additional risks due to issues relating to liquidity and the repatriation of capital.

As global investors adjust to the post-pandemic world of low interest rates and high volatility, they are seeking new sources of diversification and yield. Private markets can play an important role here, given attractive yields and low correlations with traditional asset classes.

Until recently, China’s private markets were relatively hard for international investors to access. That has changed, however. And given China’s GDP growth and the scale of its private-market asset classes – now worth $1.4 trillion1 – this is an opportunity that deserves serious attention.

Key considerations

To invest successfully in China’s private markets, international investors require partners with strong local knowledge and capabilities. They also need to consider the direction of government policy and the role of regulatory risk.

On the policy front, significant recent developments include the ‘dual circulation’ strategy and the push for carbon neutrality. Both policies are driving profound transformations in China’s economy.

Private markets offer an efficient way of capturing the benefits of these policy shifts. Historically, China’s private-market activity has been dominated by domestic investors. But, increasingly, international investors are playing a greater part.

These investors are also shifting their focus. In the past, areas such as private equity and real estate attracted the most attention, but infrastructure and private credit are now further to the fore.

Regulatory risks in context

In recent months, Chinese markets have experienced notable volatility in response to the tightening of regulations in certain sectors - notably, internet platforms and after-school education. As a result, regulatory risk has loomed large for investors in public and private markets alike.

Veteran investors in China might note, however, that the country rarely lacks for regulatory activity. What’s different this time is that some of the affected companies – notably, the big internet platforms – are global businesses. So the recent crackdown has commanded attention in a way that past interventions have not.

The themes guiding recent regulatory moves include ‘common prosperity’, carbon neutrality and fair competition – themes that are seen as entirely legitimate. A large part of the problem, then, is simply a lack of official communication – making regulatory interventions appear arbitrary and abrupt at first. In this context, it’s worth noting that private markets are typically shielded from the panic selling that can take hold in China’s retail-dominated public markets – allowing investors to focus on the overall direction of travel rather than the occasionally jerky steering along the way.

Filling the gaps

One private market that is often a direct beneficiary of policy shocks is private credit. This asset class came into its own when China launched a corporate deleveraging drive in 2016, a move that was soon followed by the crackdown on shadow banking and, more recently, by a clampdown on offshore IPOs. Whenever there’s a shock of this sort, there’s a funding gap – and it’s a gap that private credit can fill.

As a result, Chinese private credit has performed strongly in recent years2 – even as other asset classes have suffered. Its combination of high yield and uncorrelated returns makes it attractive, and the opportunity set has broadened beyond distressed and direct lending to include sponsor finance – in a pattern that’s broadly consistent with what’s been happening in developed markets.

Hunting unicorns

Chinese private equity has attracted its fair share of headlines given the number of ‘unicorns’ – companies valued at over $1 billion – that it has produced. So where do the best current opportunities lie?

Well, China’s sheer scale means that those opportunities are always going to be widely spread. With its population of 1.4 billion, China is never short of innovation or talent. And because it’s so big, there’s plenty of room for newcomers to emerge.

That said, healthcare is especially compelling at present. It’s a huge sector, so it encompasses a vast range of businesses. And given China’s demographics, there are particular opportunities in elderly care and assisted reproduction – both areas that will benefit from strong government support.

Other interesting sectors are advanced manufacturing and semiconductors, as Beijing seeks to establish entirely domestic supply chains. And there are compelling consumer opportunities too, in light of China’s growing discretionary incomes.

Good omens

Investors should always remember that China is an emerging market – with all the risks that that entails. Nevertheless, the future of its private markets looks bright.

Large numbers of highly qualified Chinese graduates have been returning to China after studies or careers abroad. Many are starting businesses – swelling the private markets in the process. Meanwhile, as China’s growth continues to moderate, the government is keen to attract foreign investors to help sustain the economy’s momentum. For that reason, the Chinese authorities are increasing support for foreign investors – through greater availability of the appropriate licences and improvements to the legal framework.

All of that bodes well: another reason for investors to give serious thought to markets that offer income, diversification and – potentially – access to future corporate giants with their highest growth still ahead of them.

1BlackRock, November 2021
2Preqin, April 2021