Institutional investors: China access

Minnesota State Board of Investments had no direct exposure to Asian private equity until about two years ago. Over the course of 2017, the $96.2 billion pension fund signed off commitments covering both ends of the market: $150 million for KKR’s third large-cap pan-Asian fund and $100 million for Asia Alternatives’ latest fund-of-funds, which targets a mixture of managers across the region. In addition, it put $100 million in Warburg Pincus’ debut China vehicle.

As investments in single-country China funds go, Warburg Pincus arguably represents the most conservative option available. The private equity firm raised $2 billion for the vehicle, which operates in tandem with its $13.4 billion global flagship fund, doubling up on China deals. It is designed for LPs that want a bit more China exposure without straying too far from the familiarity of the core Warburg Pincus narrative.

Minnesota’s approach is not unusual. There are examples of large US institutional investors moving into China funds as they become more comfortable with the strategy: Pennsylvania State Employees’ Retirement System started going directly into Primavera Capital Group’s funds having first got a taste of the manager through Asia Alternatives. But for many, the default option for getting exposure to the country is through a pan-regional fund. 

Any discussion of US investors – still the world’s largest geographical source of private equity capital – pulling back from China due to concerns over trade tensions and economic headwinds should open with three questions. Is an LP already investing in the country? If so, how? And if not, is the impetus to diversify strong enough for the investor to forgo the generally superior returns available in the US market? 

The debate is made more interesting by changes on the public markets side. Having first included A-shares in its emerging markets index last year, MSCI recently raised the inclusion factor, which is expected to see the weighting of Chinese stocks rise from 0.7% to 3.3%. This means over $80 billion of capital inflows. As a sign of how China’s capital markets are becoming more globally integrated, it may cause investors to reconsider their exposure to the country across multiple asset classes.

Within private equity, the general view is that LPs already invested in China managers are not pulling back. Some are looking to increase allocations, although this is often accompanied by a rationalization of portfolios. Indeed, endowments and foundations that “sprayed and prayed” in the mid to late-2000s, making commitments freely across the venture and growth spaces, have been in pruning mode for several years. 

Once an LP is sold on single country funds, there is seldom any retrenchment. The hard part – getting comfortable with a China-only strategy – has been done; it is relatively easy to say you want to remain invested in an economy that offers scale, strong fundamentals, and growth prospects. 

For those that haven’t made the transition from pan-regional or fund-of-funds to single country exposure – or aren’t in Asian PE at all – there might be more reasons than before to put it off. But the immediate concerns around issues such as a trade war would be one of multiple considerations. As for the others, old and new, take your pick: check size constraints, short track records, regulatory and legal challenges, not enough buyouts, not enough distributions.

“China is still considered way out there. It’s amazing how many people are still sitting on the sidelines – it seems like only 10% are meaningfully committed to China and the other 90% are doing nothing or taking baby steps by investing in KKR Asia,” one local GP remarks. 

Baby steps will likely remain the preferred approach for many investors. Discussions about geographical diversification are usually positioned as Asia versus the rest of the world. It is almost impossible to invest in Asia without getting exposure to China, directly or indirectly, but decisions about when and how can be taken by others. Without resources on the ground, LPs study China from afar, see the gulf in class between the best and the rest, and go for the perceived safe option.

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• Topics
• Greater China
• Fundraising
• Buyout
• Growth
• GPs
• LPs
• China
• Asia
• Fundraising