China is reinventing the equity markets – and Britain’s aspirations are shrinking

First, the exposition:

  1. Exuberance for equity as a class of investment reflects how confident a given society is in their future; preference for fixed income indicates the opposite
  2. China has been reinventing the equity markets for some time now, becoming the first country since the rise of the US to really have the risk appetite for it
  3. In doing so it is breaking the convention of maturing countries in the region (Japan, Korea, Taiwan) as well as ageing civilisations such as Europe
  4. As with so much else, China is the new America

The above can be seen in a number of ways. Consider this: despite the scare stories about rising Chinese debt, it is in fact equity (both institutional and private capital) which has mostly funded fixed asset investment in recent years – averaging 66% over the last decade versus just 52% over the decade before. Anecdotally too, we know that all around us in China new startups have no problems accessing micro-equity from friends and family for the most spurious of businesses.

Self-raised funding as a % of fixed asset investment in China, 1995 – 2016

Self-raised funds.png

Source: National Bureau of Statistics

Note: the NBS splits out five categories of funding for FAI, namely Government Budgetary Funds, Domestic Loans, Foreign Investment, Self-Raising Funds and Other Funds. It is reasonable to assume that Self-Raising Funds constitutes equity investment, and that a portion of Foreign Investment may also do.

Likewise, institutional equity and equity linked investments account for a higher proportion of Chinese asset allocation than their East Asian peers – and are more reminiscent of the US in approaching 60% of allocations. Conservative Japan and Korea are the reverse. Small wonder then, that annual stock turnover in China is far higher than other markets (around 5.0x compared to c. 1.5x in the US, Korea and Japan) given the limited supply of listed equity.

Equity proportion of total non-cash household financial assets, 2016

China vs peers portfolio allocation.png

Source: Goldman Sachs Investment Research, 2016

Again, this reflects the fundamentals of not only an economy, but the society on which it sits. Buoyant equity markets reflect confidence not just in business, but in the system and the role of a country in the world. This is especially true when we think about equity provided by the retail markets, either through stock markets, or its proxies, or through earlier stage funding such as seed and venture funding where China is now the world’s second largest market. The basic principle is that when tomorrow seems like it will be better than today, people will gamble.

China still has a long way to go, of course. Its stock market capitalization per capita at c. US$6,000, still lags its peers and is just one thirteenth that of the US (and no, PPP is not appropriate here). Its private equity market, though already Asia’s largest, still has some way to catch up also at only one-third of North America. Nonetheless, China seems to be well placed to pick up the baton from the US of driving the whole culture of equity and all its attendant benefits.

And it matters. The point about equity is not just that it is one source of funding, but rather that it is a source of long-term funding and seeding for growth. A country that begins preferring fixed income to equity is giving up on its future, but also giving up on the idea of being a leader in innovation and technology. It is no coincidence that America has been the world’s great equity proponent for the last century and the cradle of  most technology; or that China is following in its footsteps. These are the hallmarks of “big countries” that make their own rules and are a force in the world.

On the other hand, a country like the UK should be very worried indeed: equity in portfolio allocations has declined alarmingly from well before the 2008 crisis. This reflects some ageing – but the ageing profile is less severe than many of its neighbours. Rather, I believe it reflects a psychological retreat from aspiration.

Changes in broad strategic asset allocation for UK plans, 2003 – 2017

UK asset allocations

Source: Mercer European Asset Allocation Survey 2017

This, much more than Brexit or the reduction of blue water navy capacity, indicates the decline of British aspirations. On a recent podcast, someone asked “but how close is China to really producing an Apple?”; the curt reply came, “how close is Britain?”, alluding to the even greater absurdity of such a prospect. If this continues, Britain will certainly no longer be a “big country”.

Private equity with Chinese characteristics

Elsewhere, I intend to reflect on my pet theme that China is reinventing – and indeed single-handedly resurrecting – equity as an asset class. In my opinion, this reflects an underlying self-confidence and correlates with the emergence of other equity cultures such as the Netherlands in the 18th century, England / Britain in the 19th and America in the 20th century, in contrast to the contemporary Japans, Koreas and Taiwans of this world.

In the meantime, developments in Chinese private equity are also worth noting. For a start, when we talk about private equity in Asia ex-Japan, we are effectively talking about just one country: the PE market in Greater China reached US$222bn in 2016, whereas SE Asia combined only managed US$37bn. The ASEAN region has not yet emerged as a market of material scale.

However the prevailing orthodoxies of PE in China are also showing that the market will not come to simply resemble OECD behavior. As many observers will know, Chinese funds operate in a grey area between classic private equity and venture capital, and sometimes throw in an element of special situations or even hedge funds to boot. This comes through in the types of deals that are done – whereas conventional buyouts still account for almost 80% of the N American market, in China this is just 20%. Instead, growth capital and PIPEs account for a much larger chunk, itself revealing that PE funds typically take smaller stakes in Chinese targets and rarely buy the whole company.

Asian private equity deals by type (2012 – 2016)

PE by type

Source: AVCJ and Prequin via Bain Asia Pacific Private Equity Report 2017

Why is this? There are a number of reasons which play a part:

  1. Stage of development – the simple point that in a high growth market, sellers may be younger and in any case desire to have a greater piece of the future upside that a company might yet deliver. It also means that there is less appetite for use of debt in the transaction.
  2. Exit liquidity – by far the biggest problem PE funds have had in emerging markets is a clear pathway to exit. Recent turmoil in the Chinese stock markets for instance cause a lower risk appetite for funds, who may find it easier to sell a stake than to shepherd the company to IPO.
  3. Control issues – perhaps the most important matter, PE funds do not always have the confidence to take a company over completely since they will be susceptible to the vagaries of China country risk. A partner of some sort often seems necessary to keep a company functioning the way it has been historically.
  4. LP involvement – this leads neatly to the preponderance of strategic investors who exist in the market, and who it is better to work with than against. LP involvement in deals stands at 29% in APAC and an enormous 57% of deals over US$1bn, compared to a global average of just 17%.

LP involvement in transactions

LP involvement

Source: Bain Asia Pacific Private Equity Report 2017

So where does all this leave us? In my mind, there are a range of different players in the Chinese PE market, and they fulfill a range of roles. On the one hand, there are the classic international players, but often these are not capable of realistically doing a deal on their own without some sort of local partner angle. On the other end of the scale, you have the very Chinese funds who retain many of the classic characteristics of Chinese business ambiguity in their dealings – at times almost seemingly linked to the state. In between you have the good stuff – the international firms who have really localized and look and smell like Chinese funds; and the few local funds who have really made an effort to westernize in their business practices, if not their focus.

Here, purely subjectively based on my own experience, is an overview of the landscape of funds in and around China:

Chinese PE.png

This will cause many an argument, I am sure. But I have tried think about ways of reflecting the degree of “localisation” too. The best I could come up with involving an excel spreadsheet was to analyse where these funds were keeping their staff – the more onshore, the more localised they might be supposed. The results were interesting if not conclusive:

PE by office.png

Source: company websites

Warburg Pincus and Blackstone represent good counterpoints. Warburg is by common consensus one of the most successful foreign funds in China, and its staffing reflects this since more than half of the Asia employees are based in Beijing and Shanghai. This reflects the 26 Greater China deals they have done against the 4 in ASEAN. Blackstone on the other hand, prefer to hub-and-spoke out of Hong Kong (a business model which has had its day, as I have written before). Their deal count is correspondingly lower. It need not be added that sheer numbers of staff can help, but only if they are the right staff in the right places.

The lesson of all this is simple: China will be a very large, profitable private equity market, but it will do so on its own terms. As with much else, assuming that China will develop along the lines of its OECD counterparts is a recipe for disaster. Whilst it has some of the framework for creating a functioning market, the behavior will be totally different. Foreign participants will have a role, but they will have to adapt. This will be, as Deng Xiaoping said, private equity “with Chinese characteristics”; but perhaps we can also add, it does not matter if it is a local cat or a foreign cat, as long as it catches deals?

Why Simplified Chinese does not mean simplistic

Far from being an act of vandalism, the Simplification process should be recognised as an intellectual achievement rivaling Johnson’s dictionary


The most extraordinary aspect of perusing the National Museum in Taipei is not just the artifacts on display, but the story it tells about Chinese history. Among the other unparalleled treasures, there is a room of printed texts from throughout the ages and it is almost incomprehensible to those of us schooled in the West that upon seeing some writings which look completely recognizable and fresh in terms of style and font, to look down at the label and discover it is in fact an original from the Song, the Tang or, in some cases, the late Han dynasty. In English, we could barely make out Chaucer in its original form, let alone Beowulf; yet an educated Chinese person could visually (if not intellectually) make out every word from these texts.

Purely as a numbers game, it seems inevitable that Simplified Chinese characters, as established by China in various rounds of reform from 1956 onwards, will win out in representing the Chinese language. By every measure, Simplified outstrips Traditional complex characters in usage and the education of new learners whether ethnically Chinese or foreign. Yet if one examines the rhetoric that still emanates from Greater China and in particular Taiwan, it becomes clear that although this is known, the declining world of Traditional Chinese still grips the moral high ground. But the common, non-academic proponents of Traditional labor under two common misconceptions.

The first and most obvious fallacy is that simplified writing reform was undertaken as random vandalism. It is frequently cited that learners of both languages often arrive at the conclusion that much of the shortening has been the work of Communist progressivism, purposefully disregarding the features of an ancient civilization. Yet this is far from the case. Only a small portion of the simplification process involved wholesale substitution of components or, in extreme cases, hatcheting of words. On the contrary, many of the new forms reached back into various strains of traditional Chinese including ancient alternative and vulgar forms, commonly used short hand and caoshu (cursive) print representations. The thousands of delegates meeting in 1956 searched far and wide for forms which could be best reconciled sympathetically with the language which already existed, and in many cases did so quite elegantly. The fact is that the simplification process, for all its imperfections, remains a monumental intellectual achievement which stands alongside Johnson’s first dictionary.

The second mistake is to ignore the fact that impetus for language reform has been long-standing, and natural. Simplification  had been discussed throughout the 19th century and a lesser version had even been implemented (albeit only for six months) in China under the Kuomintang in 1935. Lu Xun, China’s most prominent writer of the 20th century, had gone as far as to say that “if Chinese characters are not destroyed, then China will die”. Yet this is not the only evidence of natural evolution – Japan simplified its version of Chinese (kanji) in 1946 and the introduction of shinjitai was itself a form of linguistic reform. Likewise have the Koreans and Vietnamese slowly changed the usage of their hanzi (mostly for local terms) to the extent that both, like Japanese, have characters unique to their own language. And of course, controversial reordering of language is not just limited to logographic languages, as the much-debated 1996 German reform demonstrated. Of course, the timing and extent of the jiantizi was very much a choice of the Communist Party but they were only tapping into what was an ongoing debate about how the language should move forward. For sure, reform was not just a Communist conspiracy.

The question should therefore really center on whether the process has been executed well, and it is here that the communities in Taiwan and overseas have been particularly vocal. Without going into the details here, the reality is that there were good and poor simplifications in the process. Some of the less controversial changes might include the word meaning “to learn,” changing 學 [xué] to 学 for instance, since the original does rather evoke the over-burdening of a child’s head with the excesses of Traditional stroke counts. Likewise the adjustments of the word for “energy,” as 氣 [qì] to 气, or “to be” as 為 [wèi] becoming 为, which are both so “elemental” that not much is lost. Indeed the adoption of 台 [tái] (from 臺) even in Taiwan, is indicative of the necessity of some changes.

Against this are the changes whose aesthetics are so difficult to swallow, such as the change from 廣 [guǎng] to 广; the unsatisfactory merging of words based on phonetics such as both 髮 [fā] and 發 [fā] become 发; and those changes which are perceived as being purely political such as the conversion of 華 [huá] to 华, and the so-called “国-phenomenon” as identified by Zhao and Balduff in Planning Chinese Characters (2007). The most prominent rallying cry of all for the Traditional Chinese community is of course was the heartless [pun intended] extraction of 心 [xīn] out of 愛 to give us the word for love as 爱 [ài]. Without doubt, these could have been done more sensitively.

The balance sheet is mixed, and Simplified Chinese is not to be defended in and of itself per se. However (and leaving aside the arguments over literacy which – very broadly – support Simplified), the reforms have one important anthropological argument in their favor: they recognize constant evolutionary change. On the Mainland, there have been effectively five rounds of reform in 1956, 1964, 1977, 1986 and 2009; in Taiwan the written language has remained ossified, with a commensurate impact on its viability. The problem across the Strait and elsewhere in the Traditional Chinese world is that the social, intellectual and political opposition to Simplified script leads to the ultimate fallacy: that Traditional as we know it today is, effectively, “perfect.” It has been done, the process has finished and there is nothing left to fix. This can be neither logically or empirically true.

The truth is that, had the Communists never won the war, and had Mao and others not pushed the reform agenda strongly, Chinese written script would have changed at some point. Around the margins, evolutionary use would have materialized; and it is quite possible that a centralized standardization of some sort may have been instituted. Modern Chinese would therefore be something in between today’s Traditional and Simplified. It is probably time for the Traditional school to recognize that, even if they do not agree with everything that has been done, the cause was more natural and noble than has been given credit for.

This piece was originally published in Caixin Online in April 2015.