Once a focal point for Asia’s fastest-growing private markets industry, China has become a riskier bet for the region’s investors, with the latest US trade restrictions making it even more challenging to invest in the country.
President Joe Biden’s executive order to ban investment in semiconductors, quantum computing and specific AI systems is of particular concern to tech-focused venture capitalists. But the new policy also has consequences for private equity.
There are still opportunities to be found in China, but its appeal among investors in Asian private equity is, at the very least, diminished. At the same time, those who continue to invest in the country will likely have to find new ways to navigate regulations as they contend with greater state oversight.
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A decade ago, the conversation surrounding China focused on new opportunities, and how PE investors could tap the emerging superpower’s increasingly affluent 1.4 billion-plus customers. Ironically, this same growth story has made China a rival to the West, fueling mutual distrust and hindering investment flows.
Private equity fundraising in China has dropped significantly. According to PitchBook data, there have been just nine fund closes this year, raising a collective $2.7 billion. At the current rate, the total number of fund closes will be the lowest of the past decade.
Meanwhile, overall foreign investment is taking a hit. Government figures revealed this month that direct investment liabilities, a measure of foreign direct investment, fell to $4.9 billion in the second quarter—an 87% drop from the same period a year ago.
While this decline in investment can be partially attributed to a broader global downturn, there are several other economic and political factors at play. In addition to US restrictions, China has brought its own rules limiting foreign investment in 2020, with so-called negative lists prohibiting dealing in certain sectors.
The same year, in the midst of a strict zero-COVID policy that had already spooked investors, Beijing launched a crackdown on the tech sector. As part of the crackdown, the government blocked Ant Group—the operator of mobile payment platform Alipay and an affiliate of Jack Ma’s Alibaba Group— from going public, depriving backers such as Carlyle and Warburg Pincus of an exit. Those who already have investments are finding they have fewer paths to liquidity as Chinese companies that would traditionally have floated in the US or Hong Kong are finding it harder to do so.
Even before the latest executive order, investors have reconsidered their China strategy. There is already one high-profile case of a VC firm that has cut ties to the country. In June, Sequoia split from its China unit, citing the complexities of running a global decentralized business; it is clear the deteriorating US-China relations had also been a factor. (It also spun out its India and Southeast Asia unit.)
Sequoia is not alone. There have also been reports of several US pension funds and endowments reducing their exposure to China funds. Biden’s executive order may yet see more slow down or reverse their expansion into China.
Guiding hands
Even as foreign investors pull out, China will still have a sizable PE industry, albeit one that could see more state participation. Private market participation from the so-called government industry guidance funds (IGFs), for example, has exploded in recent years. Put simply, IGFs are public-private funds that raise capital from a mix of government agencies and institutional investors with the purpose of directing capital to certain sectors in accordance with China’s industrial policies. According to data from Beijing-based Zero2IPO Research, there were 2,107 IGFs set up or in progress as of the end of 2022, investing 6.51 trillion yuan (about $896 billion).
Moreover, investors still focused on China are increasingly looking to raise funds in local currency—in some cases with state-backing—making it both easier to raise from domestic LPs and invest in a broader range of industries. In February, it was reported that Warburg Pincus is raising its maiden yuan fund, targeting an equivalent of $439 million. A month later, secondaries investor Coller Capital raised its first yuan-denominated vehicle, targeting 1.5 billion yuan with the backing of local governments.
Other investors in China are still seeing growth opportunities in sectors that do not carry the same political risk as technology. Among them is Derek Sulger, the founder of Shanghai-based Lunar Capital, which focuses on scaling businesses in China’s luxury goods sector.
“That is something that we think remains extremely exciting because, despite all the concerns that people have in this region, the one thing everyone agrees on is that the spending power is still there,” he said. “And that’s really not just a domestic story—it’s more of a global story.”
Investors are being reminded that while China remains Asia’s largest economy, there are opportunities elsewhere in the region. This is particularly true in Southeast Asia and India—the latter of which saw PE deal value hit $19.4 billion across 130 deals this year—putting the country on course to match, and possibly exceed, the total for each of the two previous years.
Featured image by Jenna Pluimer/PitchBook News
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