(Bloomberg) — From a posh Hong Kong office on a Saturday, a group of 20 ultra-wealthy investors phoned Carlyle Group Inc.’s head of private wealth management for Asia.
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Mostly Chinese, each had earmarked at least $10 million for alternative investments, and they were there to assess the potential benefits of putting their money in Carlyle’s private equity funds.
The meeting reflects the confluence of two trends that are reshaping the landscape of private equity in Asia. On the one hand, China’s wealthy are exploring larger investments in private assets as they seek to insulate themselves from wild swings in public markets. On the other hand, companies like Carlyle and KKR & Co. are increasingly courting the wealthy amid slowing allocations to the region from some of the world’s biggest institutional investors.
“Wealthy Chinese are very interested in increasing their asset allocation to private equity investments, in part to stay out of choppy secondary markets,” said Nick Xiao, chief executive of wealth management firm Hywin. International, based in Hong Kong, which helped arrange the meeting between its clients and Carlyle. Meanwhile, for private equity firms, “with owners of global institutional assets recalibrating exposure to this region, it becomes extremely important for them to seek money from high net worth individuals.”
Oaktree and Schroders also handle money for Hywin clients, while CDH and Hony Capital worked with the multi-family office on fundraising, according to Xiao.
Schroders and Hony did not respond to requests for comment on the story, while CDH and Carlyle declined to comment. Oaktree did not immediately provide comment.
Earlier this year, the Texas Public Education Employees Pension Fund announced it would halve its exposure to Chinese equities, showing how more cautious some institutional investors are becoming in the region. China’s stock indices have fallen this year amid strict Covid lockdowns and a property slump in the country. They have seen strong sales again in recent days after President Xi Jinping stacked the country’s leadership ranks with his allies.
Institutional investors often have mandates that dictate the ratio of private assets to public assets. This means that many cannot undertake non-public investments after the value of their publicly traded stocks and bonds has declined. This poses an increasing challenge for private equity firms to raise funds, causing them to turn to deep-pocketed individuals who collectively provide a larger pool of money to draw from.
Globally, the wealthy have the potential to play a bigger role than institutions. High net worth assets could reach $120 trillion by 2025, nearly double the size of pension funds, according to estimates by PricewaterhouseCoopers LLP.
China is particularly important because it had the second-largest number of super-wealthy people with wealth of at least $50 million in 2021, behind only the United States, according to a Credit Suisse report. The number of such people in China is expected to increase from 32,710 in 2021 to 60,000 by 2026, much the same as in Europe as a whole.
“High net worth individuals filling the gap for institutional investors in equity is a global trend,” said LH Koh, Asia Pacific co-head of global family and institutional wealth management at UBS Global Wealth Management. “It’s pronounced in Asia because Asian wealth growth is higher.”
For wealthy Asian and particularly Chinese clients, the opportunity to invest in private equity firms is of added interest as it offers a rare glimpse into a once elusive world.
“It’s always a novelty for high net worth individuals to have access to KKR’s funds, which were primarily open only to institutional investors, sovereign wealth funds and pensions,” said Markus Egloff, head of private wealth management. in Asia at KKR, referring to the Asia region. Private wealth accounts for 10-20% of KKR’s annual fundraising globally, and it could rise to 30-50% in the next few years, he said.
Winning over wealthy Chinese remains a newer strategy for many funds. For some of the big global funds “they have become so large that they have capped all institutional capital available to allocate alternatives,” said Philip Hu, managing director of Primavera Capital Group, which manages $20 billion in assets. “So what happens next is you get into high net worth.”
However, a private equity strategy is not always a safe bet for the wealthy. The cost of debt used to fund large buyouts has jumped as rates climb. Unlisted assets are also rarely priced – a process known as “marking to market” – which can make them artificially attractive. Many investors have been burned by bets on Chinese tech startups, especially in the fintech and education sectors, following a policy shift. Given the long-term commitment of funding, wealthy individuals could sacrifice cash for returns.
For more, read: China’s EdTech Assault Hits Tiger Investors in Temasek
Morgan Stanley expects the private capital market to grow at an annual rate of 12% to reach $17 trillion in assets under management over the next five years. Still, the broker added that “it is less clear whether, in a higher interest rate environment, investors will continue to sacrifice liquidity for excess return.”
SoftBank Group Corp. founder Masayoshi Son’s Vision Fund is a prime example of how betting in private markets can go downhill. His company posted a record loss of 3.2 trillion yen ($22 billion) in the three months to June, mostly due to markdowns after the estimated values of companies in his investment portfolio fell.
Some companies like UBS encourage their high net worth clients to take a portfolio approach when backing private equity funds.
That way, when the funds start paying returns from the sixth or seventh year, they turn into cash flow as a form of return for investors, Koh said. “The strategy is to invest in a portfolio of funds, taking an endowment type approach.”
–With help from Cathy Chan.
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