China: lost in transition by Theo Sofios, Portfolio Manager - Perpetual

During March 2012 members of Perpetual's Multi Manager Investment Team travelled through China. The focus was on private market investments. In Hong Kong and Mainland China we visited a broad spectrum of private market fund managers, visited the outposts of our developed market private equity managers, toured commercial and residential property developments and, visited local subsidiaries of some western owned and listed companies.

Notwithstanding the challenges faced by market participants, the sheer scale of the opportunity in China will continue to attract the heightened attention of onshore and offshore, private and institutional capital. The same market participants need to be acutely aware of the real risks associated with private market investments and have a pragmatic time frame and return expectation in light of those risks.

We were surprised by the consensus view that the Chinese Communist Party (CCP) will manage the economy appropriately, despite the challenges it faces around energy, pollution, social welfare, affordable housing, food supply and a fixed currency regime. We were equally surprised and suspect that as an entity, the store of wealth held by the CCP overshadows that which is held by the Vatican.

We came away being neither China bulls nor bears. Nor do we particularly subscribe to the view that the economy will continue its upward trajectory (with hiccups along the way), or that a crash is pending on the back of a property bubble.

There were pockets of the market that raised a cynical eyebrow, namely premium residential and premium retail. However, when it comes to private markets, we simply acknowledge that we need to be aware and comfortable of how and what we are investing in, if we invest in China. If an investment does well it needs to do well for the right reasons. An investment also needs to return capital within an expected time-frame to compensate us for the explicit and implicit risks involved.

We also acknowledge that if it goes badly, the final outcome will be skewed to the downside.

Against this backdrop we are not trying to build a road map for investing in China. We have merely begun to scratch the surface. One thing we learnt very quickly is that China changes at a fast pace that the road will zigzag along the way. We also believe that there are some strong medium to longer term transitional undercurrents occurring in China that after two decades of uninterrupted global growth, are now occurring against the backdrop of a very different and challenging global environment.

Instead, we look to develop a set of navigation rules for investing in private markets in China. If we do invest we will look to back the people who align themselves with those rules, a set of rules that we will reference when testing an investment thesis; a set of rules that we will use as a guide so as to avoid being 'lost in transition'.

This information has been prepared by Perpetual Investment Management Limited (PIML) ABN 18 000 866 535, AFSL 234426. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. The views expressed in this article are the opinions of the author at the time of writing and do not constitute a recommendation to act.

Any information referenced in the article is believed to be accurate at the time of compilation and is provided by Perpetual in good faith. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. No company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor's capital.