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For … A short list of dedicated China long/short hedge funds offer strong appeal and have demonstrated credible track records. Cambridge Associates will continue to own the private … The IT return was mostly driven by write-ups in the 2007, 2011, 2010, and 2012–14, and 2016 vintage year funds (in rank order) which, combined, represented about three fourths of the sector’s write-ups. Four sectors dominated investment activity in first half 2019. The breakdown provides context when comparing the performance of the two indexes. A-SHARE DIVERSIFICATION BENEFITS OFFSET HIGHER VOLATILITY AT PORTFOLIO LEVEL. As of June 30, 2019, the database comprised 1,879 US venture capital funds formed from 1981 to 2019, with a value of $266 billion. Both A-share and All-China managers have the opportunity to add value to portfolios through diversification and manager alpha. Notes: In the bottom chart, China credit growth is the de-trended stock of total social financing less equity issuance and includes all local government bonds. Despite representing the smallest margin of difference in three years, it still extends the seven-and-a-half year trend of distributions outpacing contributions. FIRRMA gives CFIUS an expanded role in reviewing foreign investment in US “critical technology” and “critical infrastructure.” FIRRMA’s final regulations are not expected until later this year or early next year; however, interim regulations established a CFIUS “pilot program” focused on 27 industries, including US biotech, semiconductors, nanotechnology, and computer storage device manufacturing. For vintage year 2008, the lowest performing of the group, healthcare and consumer discretionary valuations drove returns. AS OF MARCH 31, 2019. page | US PRIVATE EQUITY (LEGACY DEFINITION) OVERVIEW. Failing to consider the exposure to China in the portfolio when adding dedicated China manager can result in too much China overall. Further, according to research by investment manager Matthews Asia, a large number of China A-share companies are “value creators,” which they define as non-financial companies that generate a five-year average return on invested capital greater than their cost of capital. During first half 2019, emerging markets PE/VC funds called $11.3 billion from investors, nearly a 25% decrease from the prior six-month period but slightly above the ten-year semi-annual average of $10.2 billion. It posted an 8.1% return, the second highest among the nine major vintages, and write-ups were widespread in first half 2019, most notably in consumer discretionary and IT. Exposure to rapidly growing companies is an attractive element of growth equity, and Cambridge Associates’ operating metrics data support that premise. The remaining five sectors experienced middling returns ranging from 2.6% (IT) to 6.8% (consumer discretionary). 4 Cambridge Associates/Thomson Reuters, Buyout & Growth Equity Benchmark – Q3 2018. S&P 500 TR Index data are annual compounded return … Indeed, managers that launched A-share-only mandates years ago are now updating their prospectuses to allow investment in offshore China stocks, while offshore China strategies are adapting to include A-share investments. Those managers that include A-share listings do so in the long book, using indexes or onshore shares on the short side. By the end of this year, the inclusion factor will increase to 20% of investable market cap and begin including mid-cap stocks. Most prominent among these today is healthcare. China’s weight in a simple global stock/bond index portfolio could reach more than 6% over the coming years, based on current estimates of investible market weights. According to data from the Emerging Market Private Equity Association, 6 China-focused PE/VC funds raised US$139 billion from 2008 to 2017; only 4.5% of global fundraising PE/VC fund investment into China (by all funds, not just China-focused) during the period totaled US$114 billion, or 2.8% of global private fund investment and only 0.9% of China’s 2017 GDP. OVERVIEW. Given expensive private equity valuations and slowing growth, we favor growth equity managers that specialize—by deal type or by sector—as the market matures and differentiation matters more to the execution of deals. The breakdown provides context when comparing the performance of the two indexes. By contrast, consumer staples, healthcare, and tech sectors are far less SOE-centric. Cambridge Associates’ Private Investments Database is one of the most robust collections of institutional quality private fund performance. Non-US company exposures in the private equity and venture capital indexes have remained stable, roughly 18% in the private equity benchmark and around 10% in the venture capital benchmark as of June 30, 2019. Andrea Auerbach, Cambridge Associates global head of private investments, explains the math behind private equity valuations. Totals may not add up to 100% due … Ten years ago, as of June 30, 2009, the index included 730 funds whose value was $286 billion. As of June 30, 2019, the database comprised 839 global ex US developed markets buyouts, growth equity, and venture capital funds formed from 1986 to 2019 with a value of about $266 billion. AS OF DECEMBER 31, 2019. page | AUSTRALIA PRIVATE EQUITY & VENTURE CAPITAL INDEX. Pooled horizon return, net of fees, expenses, and carried interest. State Street’s Private Equity Index up to a 4.35 per cent in Q4 2019 State Street’s Private Equity Index up to a 4.35 per cent in Q4 2019 . On a gross, dollar-weighted basis, the three largest sectors by market value—consumer discretionary, IT, and healthcare—returned 5.0% during first half 2019, underperforming the return for all companies by more than 180 basis points. As of June 30, 2019 • USD Terms • Percent (%). Energy, real estate, and utilities sectors are not included for scaling purposes. Since 2016, IT has attracted at or above the long-term average. Venture capital fund managers called $11.2 billion from investors during the first six months, a 3% decrease from the last six months of 2018 but still the fourth largest semi-annual inflow. The illiquidity premium associated with private equity investments has the potential to produce an additional 4-6% return per year in excess of the comparable public equity markets. We approach the issue using a three-step process. FIGURE 6 EMERGING MARKETS PE/VC INDEX VINTAGE YEAR RETURNS: Cambridge Associates’ Private Investments Database is one of the most robust collections of institutional quality private fun d p erformance. Private equity includes only buyout and growth equity funds. Over time, GEM managers may underweight China more significantly, so this merits watching. More than a decade ago, Greater China mandates were common. The breakdown provides context when comparing the performance of the two indexes. Private Equity Index: D10000 "Associates Llc U.S. However, given the focus on offshore markets due to shorting limitations, regional hedge funds may be the better approach for many investors. Note: Total returns are gross of dividend withholding taxes. Capital calls totaled $51.7 billion, a 6% decrease, while distributions equaled $54.7 billion, an 18% decline from the six months ended December 2018. Over the intervening weeks, we have received many thoughtful questions regarding implementation decisions. 1 Private equity index data from Cambridge Associates. OVERVIEW. Investors were permitted to short a limited number of A-shares starting in April 2010. The emerging markets country indexes included are: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, the Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates. The four largest sectors—consumer discretionary, IT, healthcare, and industrials (in rank order)—represented 71% of the index’s value and, on a USD-weighted basis, returned 10.0%. In the first six months of 2019, in USD terms, the Cambridge Associates LLC Developed Markets ex US Private Equity and Venture Capital (PE/VC) Index returned 9.7%, following strong performance in both the first and second quarters (3.6% and 5.9%, respectively). The MSCI China Index contains 469 constituents and captures large- and mid-cap representation across China H-shares, B-shares, red chips, P chips, and foreign listings. The MSCI Emerging Markets ex China Index contains 667 constituents and captures large- and mid-cap representation across 23 of the 24 emerging markets countries excluding China, including Brazil, Chile, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, the Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates. Cambridge Associates derives its Global ex US Developed Markets Private Equity and Venture Capital Index from the financial information contained in its proprietary database of global ex US private equity and venture capital funds. MSCI Emerging Markets Index AS OF MARCH 31, 2019. page | PRIVATE EQUITY. Figure 7 shows the GICS sector breakdown of the Emerging Markets PE/VC Index and a public market counterpart, the MSCI Emerging Markets Index. The China PE/VC allocations to those sectors are 1%, 5%, and 0%, respectively. We see this in global equity manager underweights to US equities and mid- to large-cap managers’ underweights to the largest stocks in their benchmarks. Six-month returns among the six sectors ranged from 6.4% (communication services) to 17.4% (IT) (Figure 4). For first half 2019, US private equity and venture capital produced double-digit returns, as indicated by the Cambridge Associates LLC benchmark indexes. Over that same period, global public market AUM has grown by roughly 100 … All-China mandates have an additional potential advantage from having a wider canvas of companies from which to choose and from exploiting divergences between H-shares and A-shares, as many companies are listed on both the Hong Kong and mainland China exchanges. Looking past the uncertainty and negativity, investors will find a large investment opportunity set, a robust universe of public and private managers, and appealing public equity valuations.Read More », In this edition of VantagePoint, we compare and contrast the late 1990s and today; our intent is to help investors navigate this recent downturn and the next recession-related bear market (which may already be in progress), and to position their portfolios for long-term success.Read More ». US Private Equity returns vs. public market returns 1 US PRIVATE EQUITY: INTERNAL RATES OF RETURN AND MPME PUBLIC MARKET EQUIVALENTS As of December 31, 2019. FIGURE 1 GLOBAL EX US PRIVATE EQUITY AND VENTURE CAPITAL INDEX RETURNS Such a split means a reasonable baseline share of China would represent about 13% of such allocations combined. All seven of the meaningfully sized sectors posted positive first half returns (Figure 8). As of June 30, 2019, except for the most recent six-month period, the private equity benchmark had outperformed the public indexes in all time periods. The A-share market’s relatively high allocation to SOEs and “old economy” sectors offers another potential source of alpha. In communication services (the smallest of the key sectors), write-ups were relatively modest, with vintage year 2012 seeing the highest amount of writeups. Managers focused on offshore China mandates have increasingly shifted to companies incorporated in mainland China, but listed on HK and US exchanges. The breakdown provides context when comparing the performance of the two indexes. SOEs account for 43% of market capitalization of A-share stocks. Investors seeking exposure to “new economy” consumer and tech sectors might not give A-shares a second look. Cambridge Associates derives its Emerging Markets Private Equity and Venture Capital Index from the financial information contained in its proprietary database of global ex US buyouts, growth equity, and venture capital funds. Depending on allocations to these areas (both dedicated mandates and Chinese asset exposures by regional or global managers), we think it is reasonable to target China exposure as 5%–10% of the total portfolio. Notably, investment into IT companies was slow in the first six months, with companies attracting only 9% of the total invested capital, compared to the long-term norm of 13%. MSCI data provided “as is” without any express or implied warranties. GROSS COMPANY–LEVEL PERFORMANCE Why, then, should investors consider public equities? Cambridge Associates recently published the latest update of their “Real Estate Index and Selected Benchmark Statistics” summarizing private equity real estate fund performance through 2017Q1. MSCI data provided “as is” without any express or implied warranties. Given the time it takes to build allocations and that China’s share of investments is rising, 15% is a reasonable goal for China as a share of venture capital, growth equity, and buyout allocations in total over the next five years. For those with adequate selection skill, the top quartile underperformed during just two vintage years (2000 and 2002, during the bursting of the tech and telecom bubble) in US venture capital and never underperformed in US growth equity and buyouts. 1 These multiples compare favorably to those of US (1.7x) and European (1.5x) funds over the same period. Distributions from vintage years 2005–08, 2010, and 2012–14 totaled $12.9 billion, representing almost 73% of the total of the semi-annual period. Despite its “age,” the 2005 vintage saw meaningful write-ups over the period. Sources: MSCI Inc. and Thomson Reuters Datastream. Notes: “China PE/VC” is represented by the Cambridge Associates China Private Equity and Venture Capital Benchmark, which includes the following asset classes/strategies: venture capital, growth equity, and buyout. The CA Private Equity Index is a pooled horizon IRR calculation based on quarterly data compiled from 2,193 private equity funds (buyout and growth equity), including fully liquidated partnerships, formed between 1986 and 2019. Hedge fund managers in the region expect that the growing inclusion of A-shares in MSCI’s flagship indexes will help grow the lending pool and improve the ability to short a wider variety of securities in scale and at a reasonable cost. AUSTRALIA PRIVATE EQUITY & VENTURE CAPITAL INDEX. Cambridge Associates’ Private Investments Database is one of the most robust collections of institutional quality private fun d p erformance. These four vintages, in the prime of their investment periods, called more than $1.3 billion each, and the 2016 vintage called the most at $4.1 billion. Cambridge Associates’ Private Investments Database is one of the most robust collections of institutional quality private fun d p erformance. The MSCI ACWI consists of 46 country indexes comprising 23 developed and 24 emerging markets country indexes. Among the key sectors, IT earned by far the highest return and communication services the lowest. Some of the biggest investor concerns about the A-share market—high volatility, large share of state-owned enterprises (SOEs), and relatively low exposure to tech-related companies—are also the most likely sources of manager alpha. We would, however, consider managers’ structural underweights or overweights to China, particularly if they are more a reflection of a managers’ strategy rather than reflective of a view. Total fund-level cash flows (contributions plus distributions) were the third highest for any six-month period in the history of the index, a figure that has experienced a primarily upward trend since the most recent low in first half 2003. In our prior research, we defined growth equity companies as having annual revenue growth in excess of 10% and often more than 20%. Implementation options on a pure-play China basis are limited, making Asia private credit strategies the best option. The venture capital index had mixed success against the various public market indexes in periods of ten years or less, but outperformed in the longer time periods listed in the table. Sources: Cambridge Associates LLC, Frank Russell Company, and FTSE International Limited. Should investors be concerned about The Committee on Foreign Investment in the United States’ (CFIUS) expanding oversight over cross-border investments? We find attractive investments in private and public equity markets. EMERGING MARKETS Distributions outpaced contributions in 31 of the 34 quarters since the beginning of 2011. After adjusting for free float, China A-shares account for 24% of the Chinese equity market, and after adjusting for investability, 15%. Sources: BCA Research Inc., MSCI Inc., National Bureau of Statistics of China, People’s Bank of China, and Thomson Reuters Datastream. Stock index shorting is about to get easier for foreign investors as futures contracts on the portion of Chinese A-shares included in the MSCI EM Index (the MSCI China A Index) will also be available for trading on Hong Kong’s stock exchange in November, pending regulatory approval. China-based companies again received more capital than any other country, 33% of invested capital. However, it will take time for these distinctions to disappear. Read More » June 2020 Funds in the 2014 vintage, the largest vintage of those meaningfully sized, returned the most capital, topping $2.1 billion for first half 2019. mPME returns replicate private investment performance under public market conditions. NET FUND-LEVEL PERFORMANCE Story. Of the more than three dozen China A-share managers that reported performance to eVestment five years ago, 65% continued to report returns throughout the five-year period and 55% outperformed their stated benchmark net of fees. By participating in private markets, investors can tap skilled managers to concentrate investments in some of the highest growth areas, including healthcare, technology, and consumer sectors. Such managers focused on Hong Kong– and Taiwan-listed companies. As you might imagine, there is no right answer to this question. Cambridge Associates’ Private Investments Database is one of the most robust collections of institutional quality private fund performance. Based on our data from 2008 through 2017,2 growth equity companies generated an average … The Russell 2000® Index includes the smallest 2,000 companies of the Russell 3000® Index (which is composed of the largest 3,000 companies by market capitalization). Private equity includes buyouts and growth funds. Pooled horizon returns are net of fees, expenses, and carried interest. FIGURE 9 EMERGING MARKETS PE/VC INDEX COUNTRY RETURNS: The source of diversification benefits goes beyond the fact that A-shares are minimally included in the MSCI EM Index. FIGURE 1 US PRIVATE EQUITY AND VENTURE CAPITAL INDEX RETURNS 6 Note: Distributions are net of recallable returns of capital. Investors must reassess the environment on an ongoing basis to evaluate investment themes, the manager landscape, and the market environment as current investment themes mature and new ones develop. China PE/VC data are based on unrealized investments made between January 1, 2008, and September 30, 2018. Cambridge Associates, a global investment firm, will own the benchmarks and base them on financial information in its proprietary database of institutional-quality private equity … Except for first half 2019, the developed ex US and emerging markets PE/VC indexes outperformed the comparable public equity indexes (MSCI EAFE and Emerging Markets Indexes), based on mPME returns, for all time periods ending June 30, 2019, listed in. More than 90% of the capital invested by the managers in first half 2019 was allocated to consumer (discretionary and staples combined), IT, industrials, healthcare, and financials companies (in rank order). Sources: Cambridge Associates LLC, Global Financial Data, Inc., MSCI Inc., and Thomson Reuters Datastream. The State Street Private Equity Index (SSPEI) posted its second highest quarterly return in the past two years at 4.35 per cent return in the fourth quarter of 2019, up from the 0.82 per cent return in Q3 2019. Performance varied among the large vintages, with returns ranging from -3.9% (2008) to 10.8% (2016). Caryn Slotsky, Senior Investment Director 6. Public equities provide a diversified and broad opportunity set of companies at attractive valuations and the potential to add value through active management in an inefficient market. Represents pooled horizon IRR and first-quartile return for the Global All Private Equity Index from Cambridge Associates as of December 2019, which is the latest data available. Sources: Bloomberg Index Services Limited, FactSet Research Systems, MSCI Inc., PitchBook, and Thomson Reuters Datastream. In August 2018, the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) was signed into law. Copyright © 2021 Cambridge Associates LLC. The 2007 vintage year led the way, distributing almost $6 billion. Notes: Potential (Investable) weight of China bond market is based on the Bloomberg Barclays Policy Bank + Government Bond Index and the current China subset of the Bloomberg Barclays Global Aggregate Bond Index. The hedge fund manager environment is just starting to mature, with a handful spinning out from established firms. The chart highlights the venture index’s relative overweights in healthcare and IT, and its underweights in consumer discretionary, communication services, and financials. Starting valuations have a less direct impact on private investments because a fund’s manager invests and distributes capital over many years. On a gross dollar-weighted basis, when combined, companies based in China, India, South Korea, and the United States returned 7.4%, beating out the full index by less than 100 basis points in first half 2019. Notes: Correlations are based on monthly total returns, net of dividend withholding taxes. Despite its “age,” the 2007 vintage year still represented one of the largest components of the index. While there are many more listed stocks, these statistics reflect the constituents of the MSCI All China IMI Index at their full-float weights. The index is a horizon calculation based on data compiled from 2,220 private equity funds, including fully liquidated partnerships, formed between 1986 and 2019. The underweights include financials, consumer staples, and real assets (energy and real estate, which are part of the “other” category). Interestingly, this has not been a universal practice for GEM managers and their China allocations. If we exclude all Chinese stocks by looking at correlations of the two China indexes to the MSCI EM ex China Index, A-share index correlations remain lower than All-China index correlations. Data on Chinese hedge fund exposures are more difficult to come by. The Standard & Poor’s 500 Composite Stock Price Index is a capitalization-weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the US economy. Sources: Cambridge Associates LLC, FactSet Research Systems, and MSCI Inc. MSCI data provided “as is” without any express or implied warranties. The Nasdaq Composite Index is a broad-based index that measures all securities (over 3,000) listed on the Nasdaq Stock Market. In a related action, the Export Control Reform Act of 2018 requires certain federal agencies to assess the licensing requirements on US exports. FIGURE 3 GICS SECTOR COMPARISONS: CA DEVELOPED MARKETS EX US PE/VC VS MSCI EAFE 6 Preqin, Private Capital Fundraising Report, Q4 2018. As of September 2017, 971 A-share companies with at least US$100 million in market capitalization created value for investors. It provides investment portfolio management and advisory services to institutional investors, including foundations and endowments, pensions, private clients, and corporate and government entities. Private Investments data are based on trailing 5-year annual averages through December 31, 2018. Recent regulatory developments designed to protect US intellectual property in security- related industries could impact some private investments in China. However, the onshore short-selling market is not well developed. Current valuations for listed Chinese shares speak well for prospective returns, although the strong market recovery since the start of this year has moved the public equity market from fire-sale prices to good value. These eight vintages each distributed an average of about $1.6 billion in the first six months, and the two vintage years with the largest distributions, 2007 and 2008, accounted for 29% of all distributions over the semi-annual period. Figure 1 depicts performance for the private asset classes compared to the public markets. Multi-year returns reported by the Private Investments group are end-to-end. The volatility of a portfolio with 95% global equities and 5% China is similar, whether the China exposure is to China A-shares or All-China equities. March 29, 2019. The only half-year time periods that eclipse the past two occurred in 2000. While this is just 30% of China A-share companies, the number of value creating companies compares favorably to Chinese offshore equities, as well as many other emerging and Asian developed markets. The best way for many investors to use hedge funds in China may be through well-established, Asia-focused long/short managers, especially since many investors have little hedge fund exposure to the region as a whole. IT company valuation changes were the primary drivers of the semi-annual returns for all meaningfully sized vintage years except 2008. Compared with the previous six-month period (July 2018 – December 2018), limited partner (LP) contribution and distribution amounts were both lower in first half 2019, more dramatically so for contributions than distributions (the same pattern of cash flows was seen from second half 2017 to first half 2018). When setting China targets, investors should consider the impact of heavy allocations to these Asian equity and commodity-driven markets, which could also serve as a funding source for dedicated China allocations, while recognizing that these relationships may change over time, as China continues to focus more on developing a stronger consumer base and de-emphasizing the industrial sector. 8 Pitchbook, PB Benchmarks: 1Q 2018 As of June 30, 2019 • USD Terms • Percent (%)[. FIGURE 7 GICS SECTOR COMPARISONS: CA EMERGING MARKETS PE/VC VS MSCI Over the last five years, China has accounted for an average of 24% of investments in venture capital and 10% of investments in growth equity globally. Periods Ended June 30, 2019 • Percent (%). Ten years ago, as of June 30, 2009, the index included 1,303 funds whose value was $85 billion. Highlighting the index’s geographic concentration, China remains, by far, the largest country component of the index (Figure 9). 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