October 2023


China and private markets

State Street LIVE: Research Retreat offers a wide range of academic expertise and timely market insights.

After a decade of delivering remarkable growth and returns for investors, China’s venture capital (VC) industry has faced significant headwinds in the 2020s, brought on by a combination of economic and sociopolitical factors.

Josh Lerner – the Jacob H. Schiff professor of investment banking at Harvard Business School and State Street Associates academic partner – capped off Day 2 mainstage presentations at the State Street LIVE: Research Retreat in Boston with a review of the expansion and contraction of VC investment in China.

“Chinese private markets were a key focus of some of the most sophisticated global investors in the world during the 2010s,” said Lerner. “But a combination of factors has led to an abrupt decline in activity in recent years.”

Lerner’s research also examined the impact of the Chinese government’s policies on private capital, and outlined three potential scenarios for where the market may go next.

Tracking the meteoric growth of China’s VC market
With a compound annual growth rate of 12.6 percent, global private equity assets under management grew rapidly from 2001 to 2022. Nowhere was that growth more pronounced than in China’s VC markets in the 2010s.

Regulatory reforms that buoyed China’s overall economic growth also helped influence private capital developments by relaxing foreign investment restrictions and making it easier to access liquidity and raise capital.

“In the 2010s, we saw more of an evolution of China-specific business models,” Lerner said. “The market evolved much more quickly than investors anticipated, leading to an increased sophistication of groups that were in China and extraordinary growth.”

From outperformance to underperformance
After the accelerated growth of the 2010s, China’s VC markets have started to decline, with its fundraising value hitting a nine-year low of US$33 billion in 2022. Nearly four years into the decade, how do we explain this dramatic shift?

With falling initial public offering (IPO) activity and VC index returns hovering near zero, investors are feeling less bullish on China markets, and total VC investments from the United States into China have decreased sharply. Some firms are looking to restructure their operations in China to reduce their exposure to geopolitical tensions. A volatile post-COVID-19 recovery, compounded by government policy tightening, has also contributed to investors’ unease.

As a result, investors are shifting their focus more broadly across Asia – into markets such as India, and Southeast Asian countries such as Singapore.

Where will the market go next?
“While there’s no crystal ball to predict the direction of China’s private markets with ultimate certainty, we do know that government interventions play a very important role in influencing private capital investing in China,” Lerner said.

Lerner outlined three potential directions for the markets:

  • Current state is the new normal
    In this scenario, investment levels have naturally settled. China is now much more like an average market with reasonable returns and growth, but not achieving the heights it did during the 2010s.
  • Markets will see a continued decline
    As government regulations on the tech industry continue to tighten and Beijing’s relationship with Washington, DC remains strained, investors may continue to move away from China.
  • A potential ease in policy sets the markets back on track
    The Chinese government appears to be course-correcting on previous stricter regulations, issuing new reforms on private equity investments that could serve to boost IPO activities and stimulate the economy.

Over the coming months, investors will be watching developments in China’s VC markets and gauging the effects of new policies that are easing restrictions. It’s quite possible we will again see an influx of investment into China markets. Based on his previous experience, Lerner noted, “Categories of investment that folks have given up on tend to be the best places to invest.”

Stay updated

Please send me State Street’s latest Insights.