In 2003-2004, Hong Kong-based Chang Sun, managing director of private equity firm Warburg Pincus, initiated a survey of prominent economists and researchers on China’s megatrends for the next decade. Based on the study, which was conducted over one year, Sun and his team published a report titled “Ten Megatrends for China’s Next Decade.” The conclusions became the guidelines for the private equity (PE) firm’s investment in the country.

The megatrends included: massive urbanization and growth of megacities; emergence of a large, upwardly mobile, relatively affluent middle class; growth in financial services; continued large investment in physical infrastructure; global outsourcing of manufacturing to China; emergence of strong, well-managed domestic companies; aging of the population; environmental degradation and pollution; modernization of agriculture; and deregulation of health care and education.

Warburg Pincus proactively reorganized itself to tap the megatrends. It set up five major industry teams — real estate, health care, TMT (technology, media, telecom), consumption and energy, and allocated resources to these teams to explore investment opportunities. The firm has benefited from the rapid increase in property prices in China, the extensive growth of the retail industry and the enlarged coverage of the health care sector.

In early October, Sun spoke to Knowledge at Wharton on, among other things, future megatrends, including the aging population; increased environmental pollution; further urbanization; deepening of financial reform; reform of the land and household registration system; and modernization of the agricultural industry. Analyzing these in greater detail will point the way to entrepreneurial and investment opportunities in the next decade, he says.

There are challenges: excess capacity; imbalanced growth; and labor availability, costs and productivity to name a few. These will contribute to ups and downs on the road ahead. But Sun believes that China has the potential to create world-class enterprises in the next decade. “Capital will not create an enterprise; it can only support the entrepreneurs,” he says. China will need outstanding corporate leaders to “navigate the macro-wave and lead the ocean steamer ahead.”

An edited transcript of the conversation follows.

Knowledge at Wharton: Ten years ago, you did a macroeconomic survey, which summarized the coming economic megatrends in China. How did you make that forecast?

Sun: I need to clarify that report. It was not a forecast. The purpose of our efforts at that time was to outline some macro-trends for China based on our interviews with prominent economists and experts, to guide our investment strategies. To work in a huge, complicated and fast-changing market like China, private equity (PE) funds need to understand the megatrends and ride the macro waves.

Our views were not original; we filtered and streamlined the insights of experts. The so-called forecast was only one sheet of paper with 10 bullet points.

The survey process took a long time. We found that most of the economists, researchers and observers were focused on short-term forecasts and everyone had his own research interest and angle. It was hard to find someone who could comprehensively analyze China’s social and economic issues and also be practical enough to shed light on our investment strategies. We had, therefore, to filter and summarize the information.

Knowledge at Wharton: How did the conclusions on megatrends guide your investment strategies?

Sun: Before 2003, like other PE companies, Warburg Pincus didn’t set up teams by industries or categories. We had tried to set up teams by regions to do carpet bombing. We did capture some projects, but it was not very efficient. So we decided to set up teams by industries. However, China is a huge country with hundreds of industries. The question was: which one deserves more attention?

After summarizing the 10 megatrends, we had the confidence to structure teams by industries closely related to the megatrends. We focused on the outstanding players in these industries. It was quite an innovation in China’s PE circles and it worked. At present, Warburg Pincus has five key investment destinations — property, health care, TMT, energy and consumption.

Rapid urbanization has stimulated the market for property. It has also catalyzed the growth of retail chains. These trends have guided our property and consumption teams to invest in relevant companies like the Guangzhou-based R&F Properties, Hangzhou-based Greentown, Beijing-based developer Sunshine 100, Shanghai-based home furniture chain retailer Red Star Macalline and Guangzhou-based economy hotel chain 7 Days Inn.

“Rapid urbanization has stimulated the market for property. It has also catalyzed the growth of retail chains.” –Chang Sun

China’s health care reform and increased coverage has led us to invest in Harbin Pharmaceutical Group, Lepu Medical Technology, Kunming Jida Pharmaceutical, Amcare Hospital, Angel Dental and PW Medtech. Our focus has helped us harvest good projects and also gain more experience and insights to offer value-added service to entrepreneurs.

Knowledge at Wharton: Among these 10 megatrends, which ones do you think are global and which ones are unique to China?

Sun: Most of these trends have been experienced in other countries at the same stage of their development — for example, urbanization, pollution, aging population and modernization of agriculture. However, global outsourcing of manufacturing is unique to China. Data shows that China has increased its share of global trade. This has to be attributed to factors such as trade preferential policies, the movement of cheap labor to the urban areas and the improved export infrastructure in coastal regions. These factors have not been present at the same time in other developing countries in Southern Asia — India, for instance. As for urbanization, although other countries also witnessed the same trend, the speed and scale of urbanization in China are far more striking.

China-unique features are not all positive. Some are daunting challenges — environment deterioration, an aging society coming before a rich society, and the lack of comprehensive health care coverage. Take environment. Although many countries have gone through a pollution-first-governance-next cycle, China will meet exceptional pain down the same road. This is because the extent of pollution in China is unprecedented. Secondly, China has to balance pollution, the cost of governance and the growth of the economy. Thirdly, the instant broadcast of information today on the Internet and the growing awareness of environmental issues have made the job more difficult.

Knowledge at Wharton: Some trends of the past decade might speed up; others may slow down. Which do you think merit closer attention?

Sun: We are now researching the megatrends for the next 10 years. We think that financial system reform, the aging population and environment deterioration might become more important in the future.

The financial sector has been lagging behind for the past 10 years. In many industries, private sector companies have increased their presence. But finance and energy are the exceptions. In the banking sector, no private-owned bank is in top five. In insurance, only Ping An Insurance is among the leading players. Securities companies have complicated shareholder structures after institutional reform and, on the face of it, state-owned companies are still mainstream.

“When per capita income surpasses a certain level, investment demand stimulates the growth of financial markets and products.” –Chang Sun

In the next 10 years, driven by the growing economy, we anticipate that financial reform will give a big boost to financial industries. The logic is threefold: first, when per capita income surpasses a certain level, investment demand stimulates the growth of financial markets and products. Second, in an aging society, people will increasingly need to save and invest for their retirement. Third, the expansion of social security funds, pension funds, mutual funds and insurance funds will stimulate the demand for bandwidth, quality and categories of financial service. The new government has repeatedly said it will support financial innovation. Opening up some of these areas to the private sector will bring more investment opportunities.

Right now, the growth of the aging population is accelerating and the disadvantage of the one-child policy is being increasingly exposed. Even if you change the policy today, the newborn will need 20 to 30 years to enter the labor market. Meanwhile, how do you sustain the social pension system in the next decade, and how do you satisfy the aging population on service and benefits? These questions need closer scrutiny.

On environment, people now have a stronger desire for a better environment. In the past 30 years, this was sacrificed for high growth. Plus, as mentioned earlier, the news spreads rapidly once an issue has been highlighted. Generally speaking, the policymakers’ determination to address these issues is far from adequate. Environmental conflicts are getting more intensified across the country, which has led to increasingly painful choices for both the government and companies.

Knowledge at Wharton: Megatrends cannot be directly translated into investment opportunities. Among these megatrends, which areas have more potential?

Sun: It’s hard to say. Investment opportunities are created in dynamic conditions, not static. Only when demand has been created will companies need the capital to grow. Some areas sound hot now, but they are far from mature. For example, the aging society has created a lot of debate on properties and nursing for the aged. However, many are just developing land rented from the government; the business models are far from sophisticated.

Some economists have said that capital will not create ideas; it can only follow ideas. PE funds are riding these megatrends, searching for the beneficiaries of these trends, and then finding the high-quality companies to invest in.

Warburg Pincus closely watches the megatrends like accelerated urbanization, growth of the financial sector, environmental protection, and land reform. However, due to the massive scale and complicated dynamics in China, we also have to closely watch the macro background and adjust direction at times. For example, we see that consumption and retail growth are megatrends. However, with the coming of e-commerce, we have to factor this dynamic into our pattern.

Another case is urbanization. Will it make the tier I and tier II cities more concentrated, or will there be more satellite cities? If the former, the big retail chains in major cities will be stronger. If it’s the latter, the regional retailers will bring more value.

In addition, China today is still a planned economy. How some megatrends (like financial reform and health-care reform) evolve will largely depend on the policymakers and the timing of their action. Only when the government deregulates the entry barrier for private money will private banks, hospitals or schools go ahead.

Knowledge at Wharton: What are the opportunities in the finance sector?

Sun: The global experience is that when per capita income exceeds $5,000 to $10,000, the financial sector takes off. Up to now, the industry has faced entry barriers and cumbersome regulations. But I believe that once there are more reforms, new models of financing and investment will spring up. For example, online financial products. The Internet has been growing explosively in China in recent years. Companies that leverage the Internet to offer financial services will have excellent opportunities. Traditional financial institutions will be slow to transform online, and newly-born companies will find it easier to get ahead. Alipay (the Alibaba Group’s online payment company) has leveraged its strong online business ( to offer convenient online payment tools for clients. In the future, online payment, online banking, online insurance and many innovative products will flourish. This will create opportunities for VC (venture capital)/PE players.

Knowledge at Wharton: On the property market, there is a debate on its future. How do you see it?

Sun: On property, most people are concerned about the skyrocketing residential property price, a sensitive topic today. However, residential is only part of it. Property includes commercial, industrial, tourism and logistics properties as well.

The future of the market is closely connected with China’s land policy reform. The skyrocketing residential property price originated from the imbalance between supply and demand in the land market. Land is in short supply in big cities. But in the rural area and tier III and tier IV cities, the land utilization rate is very low. In the current system, farmers don’t own their land. In addition, land is tied to the household registration system, which restricted labor flow. It’s time for reform in China’s land system.

“Chinese entrepreneurs have improved dramatically in the past decade in their vision and management capabilities.” –Chang Sun

If reform did happen, what is there for investors? Farmers can move from operating small farms to modern agriculture and big farms. Land reform and changes in household registration norms can help to stabilize the floating population in their working cities and further promote the opportunities for education and health care.

Knowledge at Wharton: How does Warburg Pincus control risk in new business models or new industries?

Sun: High risk, high returns. However, in reality, these two might not match. So PE investors must evaluate the details to strike the best balance. Different funds have different styles of operation and risk preference. Risk factors include market demand, business model, product strength, competitive landscape, moral hazard, management capability, financial risk… Usually early stage VC funds are willing to undertake the first three risks, and growth funds and M&A funds are only willing to take the last two risks.

Warburg Pincus normally does not invest in new business models. When the startup reaches a certain scale and needs to expand the market or accelerate growth, our money might be more suitable.

Knowledge at Wharton: As a well-known investor, you have met numerous Chinese entrepreneurs. How do you describe their profile as a group?

Sun: Yes, I have met some of them. My impression is that Chinese entrepreneurs have improved dramatically in the past decade in their vision and management capabilities. Most of them started with a small business. But they are aggressive and hardworking. Most of them are hungry to learn; they attract good talent, study in business schools to improve themselves. Chinese entrepreneurs have transformed themselves from grassroots local tyrants to business leaders with vision and strategic minds.

At the same time, a few of them have lost their moral compass. They don’t respect small stakeholders. Although their companies succeed, investors lose. Another moral risk for investors is the so-called kick-down-the-ladder issue. Entrepreneurs forget others when they achieve wealth and fame.

Knowledge at Wharton: How do you manage your people; Warburg Pincus has a much lower attrition rate than its peers?

Sun: Our people stay for an average of 10 years. It is hard to manage smart people. On top of offering sufficient compensation, I believe the management has to build up a positive, fair and transparent corporate culture. As the boss, you have to lead; you can’t just give orders. Be an example and get all your people to work together in one direction.