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1. Members registered in this website must abide by the provisions on the administration of Internet electronic announcement service, and shall not publish information such as defamation of others, invasion of others' privacy, infringement of others' intellectual property rights, spread of viruses, political speech, commercial information, etc.
2, in all the articles published in the site, the site has the final right to edit, and reserve the right to print or publish to a third party, if your information is not complete, we will have the right to use your work published in the site without any notice.
3. During the registration process, you will choose the registration name and password. The choice of registration name shall comply with laws, regulations and social ethics. You must keep your password confidential and you will be responsible for all activities that take place under your registered name and password.
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Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

FOF Weekly Updated May 29, 2020

By He Ping, Xiong Qiao (Edi.), Matthew Tibble (Final Edi.)


As an important tool for alternative asset allocation, secondary funds mainly involve trading of fund shares, investment portfolios or limited partners’ (LP) commitments to the fund. At present, private equity (PE) is the dominant underlying fund of secondary funds. 

The Chinese PE secondary market has gradually taken shape in recent years. Large PE firms have dipped their toes into secondary funds businesses, and a few specialists in secondary funds such as Coller Capital and NewQuest Capital Partners are emerging one after another. A recent $200 million continuation fund deal between Legend Capital and Hamilton Capital especially caused a great sensation.

With COVID-19 sending shockwaves to the stock, bond and foreign exchange market, a question now arises as to whether secondary funds the attention-gaining asset allocation strategy are still suited to investment. What opportunities and challenges are there in the Chinese secondary funds market in the post-pandemic era?

A Brimming Private Equity Funds Warehouse

Currently, a swell of Chinese equity investment funds has hit maturity and are looking to the exit, creating a fertile landscape of secondary fund investment targets.

If we track this wave of PE fund establishment, we find that 2014 marked a turning point when capital flooded into the primary market. But it is 2015 and 2016 that witnessed the real peak. 

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 1. Source: Nebula Capital Advisors, Noah Research

Over the past nine years (tracked in Chart 1, above), newly registered funds have been piling up and forming a large funds stock seeking to exit. Considering a 10-year duration and a 4-year investment period, 2019-2022 will be the window for newly registered funds in 2014 to escape – in large droves – as the blue part of the chart indicates.

In this regard, secondary funds, which focus on the strategic property of transactions and can provide exits for PE funds besides initial public offering (IPO) and buyout, will have bountiful target opportunities from 2020 onwards.

An adequate supply means a wider selection of choices, and this suggest that 2020-2022 will make for three favorable years for secondary fund investments.

A Bargain Market for Bottom Fishing

State-backed capital injectors and institutional investors are two mainstreams of LP in the Chinese PE market. Looking at 2019 specifically, state-owned capital makes up 70.4% of the target size for the 2,705 newly raised funds. No wonder the Chinese PE market attaches such great importance to government-guided funds and other state-backed LPs.

However, despite a rapid growth in the past few years, government-guided funds were only meeting 40% of their target size between 2014 and 2018, according to data from Zero2IPO. In other words, PE funds established in this period are highly prone to underfunding as the possibility of LP default may rise.

 Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 2. Source: Zero2IPO Group, Noah Research 

Stricter scrutiny has also led to potential defaulting of financial institutions such as banks and insurance companies. The new capital management regulations imposed rigid bans on nestling layers and capital pool via thorough examination of qualified investors. Bank financing, insurance asset management and nonfinancial institutions were prohibited from entangling their products with PE. 2018 became the frosty winter for PE fundraising. 

With an investment strategy formulated in advance and a reserve of projects waiting to be paid on the one hand, and defaulting investors on the other, general partners (GP) can only watch as their investments are held back. 

Replacing the defaulted LPs to funnel cash inflow, secondary funds represent a straw for liquidity-short GPs to clutch to stick to the original investment plan. In this context, it is easier for secondary fund buyers to take on the goods at a discount price. 

Panicking Individual Investors under the Pandemic

2020 is harsh for people across the globe. COVID-19-related quarantine measures caused economic shutdown in the blink of an eye, particularly curbing business activities of small and medium-sized enterprises and self-employed entrepreneurs and slashing their investment willingness. The year-on-year growth of fixed asset investment is especially telling, as private fixed asset investment has dropped even more sharply than the society as a whole by 2% after the pandemic outbreak.

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 3. Source: Wind, Noah Research 

Individual LPs reluctant to sell in previous years will be proactively seeking trading because of tight liquidity under the impact of COVID-19, meaning secondary fund investors will get a better discount even for the scarce high-quality assets.

Easing Policies on Exits

While fundraising is difficult in the primary market, favorable system reforms implemented in the past two years have aided exits – such as the introduction of the star market and new regulations on stock reduction. 

The launch of star market has made it easier for qualified companies to be listed. In 2019, the public financing amount of PE or venture-backed Chinese enterprises reached a record high in 10 years, and the star market made a great contribution at 21%. Going public is easier for companies now, and funds investing in those companies also find their exits faster.

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 4. Source: Zero2IPO Group, Noah Research 

Secondary funds can also benefit from the accelerated exit of the underlying projects. Generally, secondary fund buyers are looking for asset packages with a certain duration, especially assets already in the post-commitment period, and the favorable policies will further shorten funders’ waiting time for company listing. At that time, secondaries investors will benefit from additionally accelerated distribution-to-paid-in (DPI).

Put all these things together and China’s secondary fund market looks set to enter a period of unprecedented opportunity.

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PE Weekly | News and Events in Chinese PE Market (2021.7.19-2021.7.25)
How to Exit Venture Capital Investments Successfully
PE Weekly | News and Events in Chinese PE Market (2021.7.12-2021.7.18)
REGISTER NOW !
CHINA-BASED
GLOBAL PLATFORM
FOR GPs & LPs
E-mail adress
Password
l read and agree to
Terms&Conditions
Create a new account Sign up!
Forget Password
CHINA-BASED
GLOBAL PLATFORM
FOR GPs & LPs
Name
Surname
E-mail address
Password
Confirm password
l read and agree to
Terms&Conditions
Already have an account? Sign in!
Please go to the mailbox to approve the registration
CHINA-BASED
GLOBAL PLATFORM
FOR GPs & LPs
FOF WEEKLY Account terms of service
1. Members registered in this website must abide by the provisions on the administration of Internet electronic announcement service, and shall not publish information such as defamation of others, invasion of others' privacy, infringement of others' intellectual property rights, spread of viruses, political speech, commercial information, etc.
2, in all the articles published in the site, the site has the final right to edit, and reserve the right to print or publish to a third party, if your information is not complete, we will have the right to use your work published in the site without any notice.
3. During the registration process, you will choose the registration name and password. The choice of registration name shall comply with laws, regulations and social ethics. You must keep your password confidential and you will be responsible for all activities that take place under your registered name and password.
Already have an account? Sign in!
E-mail adress

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

FOF Weekly Updated May 29, 2020

By He Ping, Xiong Qiao (Edi.), Matthew Tibble (Final Edi.)


As an important tool for alternative asset allocation, secondary funds mainly involve trading of fund shares, investment portfolios or limited partners’ (LP) commitments to the fund. At present, private equity (PE) is the dominant underlying fund of secondary funds. 

The Chinese PE secondary market has gradually taken shape in recent years. Large PE firms have dipped their toes into secondary funds businesses, and a few specialists in secondary funds such as Coller Capital and NewQuest Capital Partners are emerging one after another. A recent $200 million continuation fund deal between Legend Capital and Hamilton Capital especially caused a great sensation.

With COVID-19 sending shockwaves to the stock, bond and foreign exchange market, a question now arises as to whether secondary funds the attention-gaining asset allocation strategy are still suited to investment. What opportunities and challenges are there in the Chinese secondary funds market in the post-pandemic era?

A Brimming Private Equity Funds Warehouse

Currently, a swell of Chinese equity investment funds has hit maturity and are looking to the exit, creating a fertile landscape of secondary fund investment targets.

If we track this wave of PE fund establishment, we find that 2014 marked a turning point when capital flooded into the primary market. But it is 2015 and 2016 that witnessed the real peak. 

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 1. Source: Nebula Capital Advisors, Noah Research

Over the past nine years (tracked in Chart 1, above), newly registered funds have been piling up and forming a large funds stock seeking to exit. Considering a 10-year duration and a 4-year investment period, 2019-2022 will be the window for newly registered funds in 2014 to escape – in large droves – as the blue part of the chart indicates.

In this regard, secondary funds, which focus on the strategic property of transactions and can provide exits for PE funds besides initial public offering (IPO) and buyout, will have bountiful target opportunities from 2020 onwards.

An adequate supply means a wider selection of choices, and this suggest that 2020-2022 will make for three favorable years for secondary fund investments.

A Bargain Market for Bottom Fishing

State-backed capital injectors and institutional investors are two mainstreams of LP in the Chinese PE market. Looking at 2019 specifically, state-owned capital makes up 70.4% of the target size for the 2,705 newly raised funds. No wonder the Chinese PE market attaches such great importance to government-guided funds and other state-backed LPs.

However, despite a rapid growth in the past few years, government-guided funds were only meeting 40% of their target size between 2014 and 2018, according to data from Zero2IPO. In other words, PE funds established in this period are highly prone to underfunding as the possibility of LP default may rise.

 Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 2. Source: Zero2IPO Group, Noah Research 

Stricter scrutiny has also led to potential defaulting of financial institutions such as banks and insurance companies. The new capital management regulations imposed rigid bans on nestling layers and capital pool via thorough examination of qualified investors. Bank financing, insurance asset management and nonfinancial institutions were prohibited from entangling their products with PE. 2018 became the frosty winter for PE fundraising. 

With an investment strategy formulated in advance and a reserve of projects waiting to be paid on the one hand, and defaulting investors on the other, general partners (GP) can only watch as their investments are held back. 

Replacing the defaulted LPs to funnel cash inflow, secondary funds represent a straw for liquidity-short GPs to clutch to stick to the original investment plan. In this context, it is easier for secondary fund buyers to take on the goods at a discount price. 

Panicking Individual Investors under the Pandemic

2020 is harsh for people across the globe. COVID-19-related quarantine measures caused economic shutdown in the blink of an eye, particularly curbing business activities of small and medium-sized enterprises and self-employed entrepreneurs and slashing their investment willingness. The year-on-year growth of fixed asset investment is especially telling, as private fixed asset investment has dropped even more sharply than the society as a whole by 2% after the pandemic outbreak.

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 3. Source: Wind, Noah Research 

Individual LPs reluctant to sell in previous years will be proactively seeking trading because of tight liquidity under the impact of COVID-19, meaning secondary fund investors will get a better discount even for the scarce high-quality assets.

Easing Policies on Exits

While fundraising is difficult in the primary market, favorable system reforms implemented in the past two years have aided exits – such as the introduction of the star market and new regulations on stock reduction. 

The launch of star market has made it easier for qualified companies to be listed. In 2019, the public financing amount of PE or venture-backed Chinese enterprises reached a record high in 10 years, and the star market made a great contribution at 21%. Going public is easier for companies now, and funds investing in those companies also find their exits faster.

Historic Opportunities for China’s Secondary Fund Market in the Post-Pandemic Era

Chart 4. Source: Zero2IPO Group, Noah Research 

Secondary funds can also benefit from the accelerated exit of the underlying projects. Generally, secondary fund buyers are looking for asset packages with a certain duration, especially assets already in the post-commitment period, and the favorable policies will further shorten funders’ waiting time for company listing. At that time, secondaries investors will benefit from additionally accelerated distribution-to-paid-in (DPI).

Put all these things together and China’s secondary fund market looks set to enter a period of unprecedented opportunity.