China-US tensions hinder PE fundraising, redraw investment options

"Since December, every month the number of fund launches we work on has halved," James Donnan, a Hong Kong-based managing director with fund administrator Intertrust, told the Hong Kong Private Equity & Venture Capital Association's (HKVCA) China forum. "For those that do launch, the time to close is delayed as investors hesitate over investing."

This corresponds to broader fundraising trends tracked by AVCJ Research. Commitments to Asia-focused private equity funds reached $17.6 billion in the first three months, having topped $30 billion in each of the previous five quarters. China managers received $7.5 billion, the lowest quarterly total in six years.

Donnan noted that the recent drop-off has come on the back of a period of ferocious fundraising activity, which was unlikely to be sustained. Even so, one trend that appears to have become even more ingrained is the flight to quality among LPs. Commitments to US dollar-denominated China funds increased in the first quarter from the three months prior – largely due to closes by a few large, brand name managers. Donnan expects smaller GPs to have trouble fundraising over the next 12-18 months.

Aman Solomon, general counsel and CCO for Asia Pacific at CBRE Global Investors, said his firm continues to see strong appetite from offshore LPs for exposure to China. However, he admitted that a serious deterioration in China-US relations – to the point where CBRE has difficulty enforcing its shareholder rights onshore and struggles to realize investments – would threaten the status quo.

The tensions are no longer restricted to trade, with China's Huawei Technologies, the world's second-largest smart phone manufacturer, hit by actions that could prevent it from selling products into the US market and complicate efforts to source components from American suppliers. Jian Guang Shen, a vice president and chief economist at JD Digits, a finance subsidiary of JD.com, fears for what might come next, noting that China has suggested it might retaliate by restricting rare earths exports.

"It is important to prevent the escalation of the trade war into the financial sector," he said. "People in China are talking about using exchange rates and dumping US treasuries, while in the US they are talking about stopping Chinese financing. This would be damaging for both sides."

Hypothetical scenarios around decoupling and re-globalization are already being discussed in policy circles. Lawrence Brainard, chief economist for emerging markets at TS Lombard, told the International Finance Corporation's global PE conference last month that China would seek to diversify its supply chains and ease reliance on US markets, especially in areas like technology. This would prompt the emergence of large trading blocs within Asia that are not necessarily integrated with other regions.

PE industry participants are tailoring their expectations accordingly. Donnan insisted that the gap between China and the US is too wide for a trade agreement to be reached this year, with nationalistic sentiment likely to heighten the longer the impasse lasts. Investors must adapt to "the new normal" and focus more on domestic consumption plays than cross-border exposure.

"The tensions have increased China's resolve to reduce its reliance on technology supply chains from the US," he added. "There are more state-backed funds investing in technology. They have a different mindset to US funds – they are not looking to generate returns, they are looking at it from a technology security perspective. They will throw money at start-ups that reduce reliance on the US."

Investors might be able to play both sides of this equation. Taiwan-based KHL Capital has a portfolio company that makes set-top boxes for cable TV companies and sources the chipsets from a mainland manufacturer. It was instructed by regulators that it would have to use alternative suppliers, which potentially creates opportunities for manufacturers in Taiwan. At the same time, KHL is invested in Chinese private equity funds that are benefiting from exposure to the domestic semiconductor industry.

"The technology and knowhow have lagged the US and Europe, but because of these tensions, orders are skyrocketing. These companies are the only onshore source able to meet domestic demand," said Linda Luo, a managing director at KHL Capital.

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• Topics
• Greater China
• North America
• Fundraising
• Expansion
• Buyouts
• China
• USA
• Economy
• HKVCA