Covid-19 has had an effect on the Chinese economy, but not on longer term trends in the Chinese private equity market, according to Ivo Naumann, Shanghai-based partner and leader of McKinsey’s private equity & principal investors practice in Greater China.

China is the third largest private capital market in the world, of which USD66 billion was invested in private equity in 2019. The country is the third largest market for private equity today, after the US and UK.

“If you look at the private equity industry in China, in many ways it’s a growth story. Looking at long term trends over 10 years or so, you see consistent growth,” explained Naumann.

The private equity industry in China has indeed seen years of ongoing growth, but experienced a drop after 2017. McKinsey doesn’t believe this is down to weaker fundamentals of the industry, however. The global consulting group predicts the industry opportunities will still be there and is expecting more growth going forward.

Growth in the Chinese private equity market is mainly driven by three trends: a continuous growth in average deal size, a shift from minority deals to control investments, and a concentration of LP investments in the top 10 funds, in McKinsey’s view.

“The trend from minority investments to buyouts is paired with an overall slowdown of the Chinese economy. There’s a shift in how investors make money in this market. You need to be able to have control in order to add operational value,” said Naumann.

In order to do this, funds are increasingly building operational value teams that are purely focusing on how to create operational value. At the time of investment GPs need to have a very clear understanding, in addition to spotting the right industry and management team, of how to add additional value in order to gain an edge over competitors, in Naumann’s view.

He continued: “Funds also need to become deeply specialised in one industry only, or focusing on certain functional capabilities that they can bring to add value to portfolio companies. For example, hiring top notch digital talent that they deploy in their portfolio companies to accelerate digital growth. So specialisation either on an industry base or functional area becomes increasingly important. It’s also important to clearly define the strategy of the fund, and how that relates to the people in it.”  

According to Wouter Baan, McKinsey & Company associate partner in Hong Kong, many of the above mentioned trends in Chinese private equity have been building up for some time, but are really gaining significance now.

“Private equity funds in terms of fundraising have been outperforming other asset classes such as venture capital or real estate and infrastructure. Private equity now accounts for more than 50 per cent of total fundraising,” he said.

“Fundraising for buyout funds has become larger than for growth funds. The focus on buyout will likely only become stronger as funds are looking to take control of their portfolio companies,” added Baan.

In 2016, 20 per cent of fundraising in China went to the top 10 funds, and this has now increased to 30 per cent, according to McKinsey’s new report on private equity in China.

“Although you see a similar trend in the US market, we see it becoming slightly more concentrated in China. Factors such as track record have become clearer over time; it’s now easier for LPs to look at who’s performing well. Many of the LPs prefer putting their money in a select number of funds,” explained Baan.

On the other end of the spectrum, first time fundraisers are struggling – only GPs with a track record were able to fundraise in China last year and in 2020, the report showed.

Source: Privateequitywire

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