During the fourth quarter of 2015 and into the first quarter of 2016 as our teams assembled this report, Chinese capital markets were extremely volatile, with most equity-focused hedge and long-only funds reporting being down double digits. Despite these worries, we remain of the view that 2016 is starting out in a very similar fashion to the start of 2015 – far more “business as usual” than what the deep pessimism in the foreign press would otherwise suggest.


Our businesses ended the year in relatively good shape, with reasonable growth across our larger businesses. This has continued into the first quarter of 2016, with most of our businesses off to a somewhat stronger start versus last year. While there is a risk that a weaker RMB and public comparable valuations may impact the value of our portfolio, at present we expect growth to handily offset this. In terms of generating realizations, the end of 2015 and early 2016 was a terrible and challenging environment for liquidity. However, we find ourselves in the unique position of having control over a growing group of businesses, and believe that accelerating mergers and acquisition activity, a drive towards consolidation, and far more rational validation expectations will lead to a healthy realization trajectory in the near future. These factors, along with the rapidly growing succession related challenges in the PRC business community, are also driving our pipeline, which has swelled considerably. The opportunity we see here is to continue buying small, professionalizing, growing and selling bigger. There is limited competition for the small and medium sized enterprises we target to buy, but a growing appetite for larger, solidly mid-market, professionally run companies we can build.


Following China’s recent political meetings, or the “two sessions”, it is increasingly clear there is disconnect between media reports on the economy and reality. Disparities are developing between what was set forth in the 13th Five-Year Plan and what is happening on the ground, academics are increasingly becoming disconnected from practice, concerns about economic policies are growing, and government policymakers are being challenged to fully understand – and more importantly address – the current needs of Chinese businesses. Within this environment we see opportunity to take action.


It is important to note that China’s challenges today are different than situations of the past, when consumers were hard fought to obtain basic necessities and enterprises faced general production and capacity shortages. Today, the challenges faced by consumers are centered on quality of life pursuits and efforts towards achieving a greater level of prosperity. It is also important to understand the changing investment landscape in China, which has historically been dominated by government-led programs. Reforms are gradually moving away from this model and towards private-led investment, especially as industries become increasingly diversified and complex in nature. Policymakers are allowing market forces to allocate capital and are deploying a selectively hands-off approach, as they acknowledge that they can achieve more by focusing on the administration and the simplification of commerce, especially in aspects of the economy which are driven by choice – e.g. consumption. We also see sustainable social and economic trends developing that indicate consumer businesses will present clear investment and growth opportunities for the long-term, despite interim pressure. We are less concerned on the state of the capital markets, which in China is less correlated with disposable income than as compared to western economies. Steady growth in household income, rapid urbanization and the boom of online shopping is also changing the composition and nature of consumption. Consumer demand is healthy in sectors including food & beverage, entertainment, apparel, lodging and transportation, health and premium lifestyle products.


As our most recent fund begins to deploy capital and acquire leading consumer businesses, we argue that over the next ten years, investment capital should focus on industries in need of operational value-add to achieve growth through management enhancements, product and marketing upgrades, cost control initiatives and efficiency improvements. Headwinds in China's economy and capital markets have historically afforded astute investors the opportunity to identify these opportunities for improvements. Slowing growth in industrial transformation has also created opportunities for acquisitions at reasonable prices, especially for companies building scalable platforms through accretive acquisitions of premium brands in areas beyond the commonplace tier-1 cities.


We are more and more frequently finding ourselves negotiating with founders in China, who have developed strong businesses and are now finding it too challenging to compete and adjust to this dynamic marketplace. In addition, as retirement nears, we see clear opportunity for operationally-involved private equity firms to offer solutions. Should they be willing to take control, dedicate themselves to improving management and generating efficiencies, and ultimately pioneering expansion into new markets, the net-net result will create real value and returns for all shareholders.