In this episode of China Money Podcast, Pantheon Venture's global head of investment, Chris Meads, talks about how private equity in China has to shift strategies to succeed in the future, and how his firm is looking to back more control-oriented funds.
Listen to the full interview in the audio podcast, watch the shortened video version or read an excerpt.
Q: You are the first fund-of-funds to focus on Asia. How has the fund-of-funds space evolved in the region?
A: I guess when Pantheon started, there wasn't really a private equity industry to speak of in the region. It was very small, very niche, only a handful of funds. So, we sort of started with the industry as a whole in Asia.
Certain countries you just couldn't invest in, such as Korea. Australia was effectively shut because of tax reasons. China was opening up, but it didn't really have a private equity industry. India was very closed in those days, and had to go through deregulation.
Since then, it has grown a lot both in terms of the number of funds, the variety and the scale of money under management in the region.
Q: So which geography and industries do you favor in the region nowadays?
A: It almost doesn't matter, because by the time it becomes obvious, it will be too late to change (your focus). We are investing over the 10 to 12 year horizons. If we go back to, say, 2003, which was probably at a period of time when Asian private equity generally, but particularly China, was not perceived as favorable by foreign investors.
But paradoxically, returns from those vintages were absolutely fantastic. So it's the old story when no one wants to invest, that's when the good returns were made. I think when we looked at that market, it seemed obvious to us that most of the growth or the growth story in Asia were being driven by exports, and it's going to be switched to domestic consumption. Nowadays, it's an incredibly fashionable thing to say. But in early 2000s, that was quite hard to put yourself in the shoes that it was going to really deliver strong returns.
I think the challenge now is most of the very rapid growth opportunities in China have probably been made. So more of the growth now is going to come from productivity-led growth as opposed to just providing more capital into the system. So I think that means that we have got to focus much more on efficient investment as opposed to the quantity of the investment going into China.
I think that the domestic consumption story, which has driven growth over the past ten years in Asia more generally, has become a bit more subtle. Because like everywhere, Asian consumers are getting more sophisticated. (Investments now will need to focus on) developing the distribution networks that will be able to sufficiently meet consumer demands. So the fundamental drivers of profitable investments are changing, so we have actually backed some managers who are taking a more control-oriented investment approach to fast growing markets such as China.
Q: Beside what you just mentioned, what other qualities do you look for when you look at a fund to back in China?
A: I think we are not specifically focused on particular industries. What we are looking for is the recognition from the managers that we back, that simply investing in a very large theme like consumer growth is not enough. So we are looking, for examples, within their deal flow pipeline: were they able to carve out a niche where it's not quite so expensive? Where it's not so much competition? Or maybe it's investment in the distribution channel, because that's the bottleneck, which needs to be fixed.
All of these things will ultimately be driven by overall consumer demands, but the ability to carve out a niche which is just less competitive in terms of the investment process itself, or is able to maintain margins because there isn't much fierce competition, I think those are the key.
Q: Lastly, what is your outlook for private equity in China for the next one to three years?
A: Next one to three years, I'd say it's possibly going to be a bit challenging. Because I do think the slowdown in growth has probably caught a few people by surprise. I think the rate of exit liquidity is probably going to be a bit slower than what most people would expected. I would expect a slow down in the number of new funds that are merging in China over that period.
But I think a bit of hiatus and pause will be a healthy thing for the long run for the industry in China.
About Chris Meads:
Chris Meads is the global head of investment at Pantheon Ventures, a global fund-of-funds investment firm with US$25 billion under management worldwide and close to US$3 billion dedicated to Asia. Previously, Meads was at HSBC Hong Kong, Brierley Investments and CS First Boston. He was also a former economist for the National Bank of New Zealand and the Reserve Bank of New Zealand.