As the war of words escalates in the U.S.–China trade dispute, the future of crossborder investment is now in the crosshairs. While the Trump administration threatens to find ways to limit U.S. investors' portfolio flows into China, Chinese authorities announced Monday they are accelerating efforts to open their market to foreign investors.
How this drama will play out is anyone's guess, but some U.S. investors remain steadfast. After all, what do you do when the world's two largest countries are facing off in a trade war that threatens global stability? You figure that consumers will keep buying in both places, worry the world might lose in the short term, and keep investing.
That is the approach adopted by General Atlantic, a $35 billion private equity firm that was a pioneer in globalization. "I think there may be too much pessimism out there. The global economic data is not as bad as you would read every day," said Bill Ford, CEO.
About 55% of General Atlantic's portfolio is invested outside the United States, with about 10% in China. It has 18 portfolio companies there out of a global portfolio of 112. In interviews with CNBC, Ford outlined the risk of a global recession, why he's a little less worried about it now than he was at the beginning of the summer and what the firm is doing to navigate the risk — including by continuing to invest in China.
General Atlantic is one of the world's largest growth equity firms: It makes $75 million to $500 million bets on private companies all over the world. Its portfolio approach illustrates how a growing share of the world's capital aims to flow apolitically, based on long-term trends that hold true no matter what country a company happens to be located in. The trend is likely to grow as more of the world's capital is in private markets and out of public markets regulated by national governments.
"The business globalized a long time ago," Ford said. "There are as many unicorns outside the U.S. as inside the U.S. Entrepreneurship has globalized."
In the short term, however, the White House's antagonistic stance might be having an effect when it comes to China.
Other private equity firms, however, are pulling back from China. Overall, private equity investment in China fell to $9.8 billion in the first half of 2019, compared with $15.1 billion the previous year, according to the Emerging Markets Private Equity Association, based on disclosed investments.
Ford explained why the General Atlantic remains bullish on it — and is still bullish on the United States, as well. "Do we think it's going to grow 4%?" he said of the United States. "No. But does it need to? No. The United States continues to be a center of entrepreneurship and innovation, and it's increasingly a service-based economy that fares better in downturns than a manufacturing economy."
General Atlantic is forecasting, long-term, 5% to 6% growth in China. That country is also turning toward a service-based economy. When it comes to innovation, it's increasingly giving the United States a run for its money, Ford says.
For instance, Ford pointed out, China filed more than 30,000 public patents for AI in 2018 (2.5 times more than the United States). China is racing ahead with 5G networks, with three telecom operators piloting 5G in more than a dozen cities, with a total population of 167 million. China also leads the world in 5G patents, at 3,400 versus South Korea (2,051) and the U.S. (1,368).
"China also has a large, young market that enables rapid, large-scale commercialization of digital business models," General Atlantic said in a follow-up statement. "China has more than 800 million internet users — more than the EU and U.S. combined — with advanced e-commerce penetration and the mobile Internet accounting for 85% of all transactions. The country is also racing ahead in areas such as 5G and artificial intelligence."
General Atlantic has been investing for two decades in China honing in on technology, financial services and health care. The rewards, at least the unrealized ones, are rich. Its investments there include Bytedance, an AI media platform that distributes content based on users' interests in real time; Ant Financial, a fintech company that provides payments, lending, insurance, wealth management and credit scoring; and Asia Medical: a privately-owned hospital operator in heart surgery and cardiology. Bytedance's owner TikTok's 2018 pre-IPO investment round reportedly valued it at an astounding $75 billion, making it one of the world's most valuable startups.
In September 2018, General Atlantic invested $150 million in Hong-Kong-based Asia Medical. In May 2014 it led a $300 million series C round in Chinese group discount platform Meituan.com.
The trade war doesn't trump the long-term trends that make both the United States and China good places to invest, if you're doing so with at least a five- to seven-year horizon, Ford said.
But the trade war does increase geopolitical risk, and he worries about that. "We have elevated geopolitical risk everywhere you look. We have Iran, North Korea. We have poor political leadership and populist leaders around the world," he said. "And cybersecurity risk on top of that."
Ten years ago the biggest risk to the global economy came from inside the United States: a crisis born on Wall Street brought on the terrible recession of 2008–2009. Today the biggest risk to the global economy again stems from the United States: A protracted trade war with China may exacerbate tension and lead to a geopolitical shock.
In that case, all bets are off. Investee companies that are highly leveraged, lack flexible leadership or are in cyclical sectors of the economy are at risk.
"We're always paranoid about an economic downturn," Ford said. "We're 10 years into an economic expansion. You have to believe there's a downturn around the corner."
But Ford says he's a little more sanguine about the possibility of a sharp contraction than he was four months ago — mostly because of the Fed's determined moves to lower interest rates, and because the market seems to be shrugging off many headlines, like the recent bombing of energy facilities in Saudi Arabia.
In a global recession brought on by a geopolitical shock, the biggest risks could lie for and in developing economies, where many companies may be carrying debt in a currency that could drop in response to bad news, or be vulnerable to sharp pullbacks by consumers in the same boat.
Those countries are also at a more immediate risk from the trade war, if the Chinese government pulls back on investments in infrastructure or start-up companies. The International Monetary Fund estimated China is responsible for about 35% of world GDP growth.
Vanguard recently issued guidance to advisors predicting real GDP growth of 6.2% in China for 2019. In turn that means slower growth in emerging markets. Vanguard predicted 4.1% real GDP growth for emerging markets, down from 4.4%, and lowered its predictions for emerging Asia to 6.2% from 6.3% and Latin America, to 0.6% from 1.4%.
Goldman Sachs Asset Management pulled back its exposure to emerging markets' currency and debt — most likely to be affected by a decline in foreign investment from China.
But the broad idea that China might pull back on foreign investment that has propelled growth doesn't reflect complicated realities of the world. Sector by sector and country by country, the story is different. In Southeast Asia, for instance, a retreat from China might give space for other investors and buyers to walk in the door. But in Vietnam, exports continued to rise in 2019 despite the trade war. China didn't pull back on that country, Vietnamese companies continued to build stronger supply chains, and they exported 30% more to the United States than they did last year, according to a June 30 report from the Institute of International Finance.
General Atlantic has adopted a handful of strategies to navigate an increasingly global world. The three sectors Ford mentioned as important and that will likely hold up even if a global recession hits, are cloud computing, artificial intelligence and health care. Many of its recent investments have been in those areas.
General Atlantic listed the United States, China, Brazil, India and Indonesia as areas of focus. Its 150 investment professionals are in 14 offices worldwide. "Indonesia is now one of the most digital countries in the world, with an internet economy of more than $25 billion and 150-million-plus active internet users. To capitalize on opportunities in the region, we recently opened an office in Jakarta to complement our regional hub in Singapore," it said.
General Atlantic's limited partners are 50% institutions and 50% family offices, Ford said, and an increasing number of them are global, too. "One thing I have absolutely conviction about is that without being highly local you cannot invest," Ford said.
The firm has seen significant opportunity in Brazil over the last five years. Its bets there include Brazilian educational platform Arco. The company raised $220 million in an IPO on the NASDAQ in 2018 — one example of a relatively rare phenomenon, the public exit of a startup from a developing market.
Arco grew despite turmoil in Brazil, on the strength of growing number of consumers demanding education services for their children. General Atlantic invested $250 million in London-based Greensill, a finance firm that provides working capital to companies, and an undisclosed amount in Czech travel firm Kiwi.com.
General Atlantic hasn't been a top firm when it comes to early investments in unicorns. It's invested in 21 worldwide, ranking 18th in a tightly bunched list of top VC firms investing in the 344 unicorns worldwide as of May 2019, according to CB Insights.
Five years ago, General Atlantic developed a new strategy, deploying 15% of total capital to what it calls emerging growth — meaning it's making investments earlier in the companies' lifecycles, when valuations are lower. Investments in the emerging growth category are $25 million to $75 million, Ford said.
General Atlantic has a long history of adapting to trends, mostly under Ford's leadership. Founded in 1980, General Atlantic was originally the family office of Chuck Feeney, who made a fortune on duty free shops. Ford has been with the company since 1991 and became CEO in 2007, when it had $12 billion in AUM. General Atlantic's big wins have included investments in Priceline and Airbnb, among others.
Global growth equity firms have returned about 12.7% a year, net of fees, over the last 10 years, according to Cambridge Associates. "For those old enough to remember the commercials, U.S. growth equity could perhaps be called the Reese's Peanut Butter Cup of the private investment world: "You got venture capital in my private equity!" "No, you got private equity in my venture!"
VC funds returned 6.9% over the same time period and buyout funds 14.2%.
Global growth equity has been riding the middle-class wave. By 2030, 5.4 billion people will be in the global middle class, 65% of them in Asia. 90% of the next billion new middle-class consumers are predicted to be in China, India and Southeast Asia.
In a recession, buyout firms are arguably the most vulnerable, because the companies in their portfolios have high leverage, Ford said. Growth equity firms performance will depend on that rare element: skill. Firms need to make smart bets, keep leverage low on portfolio companies' balance sheets, and find buyers at the other end for their investments.
In downturns, Ford said, it's always the entrepreneurs that turn out to be the decisive factor when it comes to whether a company survives and makes money for investors. "It's hard to describe, of course," he said. "It's that elusive factor. Can they pivot when they need to, can they adapt? But when we do well, it's always because of the entrepreneur."
Correction: This story was updated to reflect that General Atlantic led a $300 million series C round in Chinese group discount platform Meituan.com in May 2014. An earlier version misstated the date.