Asia fundraising: Retail channels

More than 4,000 clients have experienced Enoch Education in the past two years. Some have been sent to the Wharton School of Business to learn about portfolio construction, to Switzerland for sessions on family office management, and to Silicon Valley for visits to Apple and Tesla. These trips are part of how Enoch, as the investor education arm of Chinese wealth manager Noah Holdings, fulfills its mission to explain to high net worth individuals (HNWIs) how private equity works.

For Noah, these relationships are big business. Last year, the firm’s wealth management unit – a distributor of domestic and offshore fixed income, private equity and secondary market products – received $159.4 million in commissions from managers and $107.5 million in service fees from clients. A further $69.3 million in service fees came from the asset management unit, which creates products such as fund-of-funds for the alternatives space.

PE accounted for one quarter of the $15.2 billion Noah raised for third-party products, and for half of the $17.4 billion it held in discretionary portfolios under the asset management business. The asset class is of increasing interest to the firm’s 135,000 registered clients as they look to diversify and internationalize fortunes that have thus far been invested in a relatively unsophisticated manner. But education efforts emphasize that PE is not for everybody.

The clients are generally not as familiar with alternatives so there is an affinity for brand-name platforms – Vincent Ng

“As wealth accumulates and individuals become more informed they want to learn from the best and mimic big institutions – and as a result they discovered private equity,” says Piau-Voon Wang, co-CIO at Noah. “However, private equity is more for HNWIs than affluent white-collar, middle-class office workers. That’s why we spend so much time on investor education, explaining that there’s a 7-8 year lock-up and the compound return may be 15% or lower, but you exchange time for returns.”

As Chinese institutional investors took time in devising outbound alternatives programs, the likes of Noah and CreditEase quietly established themselves as international LPs – Noah alone deploys $1-2 billion a year out of its Hong Kong office. While capital controls imposed by Beijing have reined in activity somewhat, China remains a key part of strategies drawn up by private banks and wealth managers to channel more Asian HNWI capital into international private equity.

“Our platform provides a connection to an underrepresented segment of the market,” says Lester Lim, associate director in the alternative investment group at HSBC Private Bank. “Family offices are active investors in the asset class – we deployed over $1 billion in alternatives globally last year and 80% of that came from Asia – but it is hard to access these people.”

Global play

This is not solely an Asian phenomenon. Of The Blackstone Group’s $367 billion in assets under management across all its strategies, retail or high net worth investors contributed about 17% as of year-end 2016. Stephen Schwarzman, Blackstone’s chairman, said in his annual letter that the firm is working to “bring institutional-quality solutions to the high net worth retail and family office channels that historically have been denied access to those types of products.”

Other listed global managers such as The Carlyle Group and KKR, which place an emphasis on accumulating fee-generating assets, are also seeking to penetrate the high net worth segment. While HNWIs generally participate by pooling their capital in a feeder vehicle that takes up a single LP position, they aren’t necessarily entering a single fund. The products offered could deliver exposure to several strategies through funds operated by the same manager.

In order to manage these deeper and more complex relationships, most global firms have investor relations teams dedicated to HNWIs and the private banks and wealth managers that represent them. For example, Carlyle’s 50-person LP relations group includes eight professionals who concentrate on high net worth distribution.

A key motivating factor is LP diversification. First, large institutional investors are seen by some GPs as increasingly difficult to service, given their tendency to push for preferential terms by virtue of their size. Second, and more importantly, these investors tend to act in concert, whether that is due to a herd mentality or a similar response to macroeconomic shocks. HNWI money can serve as a balancer.

One industry participant recalls asking the principal of a North American buyout firm why he had come all the way to China to market to local HNWIs when fund-of-funds were willing to contribute the same amount. The response was: “We want to develop private wealth and China is important. So even though it’s $150 million I’m throwing resources at this as if it were a $1.5 billion commitment.”

Richard Williamson, managing director for overseas business at CreditEase, sees this as a familiar trend. He notes that HNWI money is generally harder and costlier to raise, but it moves in different cycles to institutional capital. Moreover, trends differ between geographies: Chinese money moves in different cycles to Western money, and so might be prioritized by GPs for bringing additional diversification.

Regardless of geography, this wealth has become a sizeable target. According to Capgemini’s latest World Wealth Report, in 2015 a total of 145,200 ultra HNWIs – each with investable assets of at least $30 million – controlled $20 trillion in assets. Another 1.38 million people, with $5-30 million apiece, had $13.2 trillion. Asia Pacific is the fastest-growing market in these two categories. There were 37,400 ultra HNWIs and 431,400 mid-tier millionaires in the region in 2015, and between them, they held $8.9 trillion.

With these statistics in mind, almost all private banks and wealth managers offer alternatives exposure to their clients. “Alternatives is becoming more mainstream,” says Michael Henningsen, a partner at placement agent First Avenue. “In the past, a private bank would tell you it could sell a product but their client advisors didn’t fully understand it. Now they have specialists in alternatives.”

Pick ‘n mix

Not all of these investors are suited to a feeder fund. Wee Teck Tay, global head of private equity and real estate in the wealth management division at Standard Chartered, puts the cut-off point at $10 million in assets: those above would go direct into funds or individual co-investments; those below are most likely writing checks of between $250,000 and $1 million for a feeder. Standard Chartered offers two to three feeder opportunities – usually for a single underlying fund – to its clients each year, and the average aggregate commitment is $100 million.

HSBC is in a similar position, with four or five funds available on the platform per year, spread out evenly over 12 months to avoid congestion. The minimum check size is $250,000 but most investors are putting in $2-5 million. A single feeder vehicle might run to $200 million. “There has to be some scale to the target fund. Banks will usually need the allocation to be at least $150-200 million to make it worth their while to distribute,” explains Justin Dolling, a partner at law firm Kirkland & Ellis.

From a client perspective, access comes at a high price, but there are few other ways to enter the asset class. Fee schemes vary considerably between the private banks, but one way or another, the client ends up paying the 2% management fee and 20% carried interest charged by the underlying GP plus fees to the bank.

In certain cases, a PE firm might pay the bank a distribution fee, which would either be retained or offset against fees charged to the client. On top of that, clients are liable for a one-off fee paid to the bank for access to the feeder vehicle and perhaps also an ongoing management fee to cover administrative costs. Standard Chartered, for example, asks for an upfront arrangement fee equal to 3% of the commitment and annual trailing fees of around 70 basis points.

Just as a private bank needs a fund to be a certain size to justify marketing it as a feeder, the manager behind it must be strong enough to generate interest among HNWIs. “The clients are generally not as familiar with alternatives so there is an affinity for brand-name platforms,” says Vincent Ng, a partner at placement agent Atlantic Pacific Capital. “But you do see some of these platforms looking a bit deeper and asking what else would be viable to represent to clients. At the end of the day, the clients don’t do any due diligence, it is purely a menu option for them.”

L Catterton Asia is a good example of a regional manager that used brand recognition to get traction with the high net worth segment. Prior to its merger with US-based Catterton, L Capital Asia was a private equity business sponsored by luxury goods conglomerate LVMH, and these ties clearly resonated with HNWIs wanting consumer exposure. A feeder fund established by J.P. Morgan is said to have accounted for about half of the $950 million L Capital Asia raised for its second fund in 2013.

Crescent Point, meanwhile, represents the other extreme. The GP spent more than a decade operating below the radar on a deal-by-deal basis with the support of a family office network. It has since switched to a hybrid model with two pools of third-party capital supplementing family contributions. The first of these – worth around $200 million – was raised as a separately managed account through a private bank. This also enabled the firm to widen its network of HNWIs, according to an industry source.

A blurred line

It takes years for client advisors to win the trust of HNWI clients, and once it has been established they don’t want to let go. As such, private banks and wealth managers increasingly tailor their products to meet specific needs. The traditional feeder fund remains on the menu, but it is not alone. For example, a private bank might pre-select four funds under a particular strategy and pitch it to clients as a diversification play and an opportunity to invest in smaller funds that might not warrant a single feeder.

This blurs the line between those who intermediate products and those that create them, and for Noah and CreditEase it represents logical business development given the dynamics of the China market. “We think the fund-of-funds structure is a great product for our clients because it provides access to funds they wouldn’t otherwise get and it provides fund selection and portfolio construction, which is difficult for them to do,” says CreditEase’s Williamson. Secondaries and co-investment are also on the agenda.

Not all industry participants plan on taking this course: some say they are uncomfortable with fund-of-funds due to the added fee burden; others don’t have the resources or remit to offer such products, conscious that their relationships with HNWIs already cover a range of services that stretch beyond alternatives. But these customized approaches do potentially open up a new source of funding for private equity firms that are not among the global brand names.

From a GP perspective, these pools of capital function much like any other LP position. Responsibility for know-your-customer (KYC) and anti-money laundering (AML) due diligence, meeting capital calls and perhaps even serving on the LP advisory committee rests with the private bank or wealth manager.

Feeder vehicles, unlike fund-of-funds, do pose an additional complication when they are established solely for investing in a particular fund. Under US regulations, the GP must look through the feeder and establish that each HNWI meets the criteria to participate as a qualified investor or is not a US resident. While a full client list isn’t required, the GP would have to get comfortable with how its product is marketed. This is easier if the counterparty is an international private bank rather than an unknown Asian wealth manager.

As to whether HNWI feeder vehicles can replicate the impact they are having with the global managers at mid-market level, opinion is divided. A PE firm raising funds of limited size on an infrequent basis, may welcome feeders in the interests of diversification, but it doesn’t have access to the investors or visibility about re-ups. “Would an oversubscribed manager take two pension plans and a sovereign fund or $300 million from a feeder? I think it might be the former,” says Dolling of Kirkland & Ellis.

Even though classic sources of institutional capital will remain the foundation of most successful fundraises, the stigma previously attached to “retail money” is dissipating. As these investors grow in wealth and sophistication, the infrastructure has been put in place in Asia through which those without the means to go direct can participate in the asset class. For now, attention is largely focused on global players that have the scale, internal resources and brand names to make it happen.

“There are still a lot of misconceptions about what this investor group is like; and it not an easy space, with a lot of work in terms of servicing and legal and regulatory compliance,” says Noah’s Wang. “But the old school bias against retail investors has gone. When I joined Noah I was worried we wouldn’t see the best deals and funds, but the reality is all the big names are moving in this direction. It is important strategic initiative.” 

 

SIDEBAR: Fundraising disrupted 

"You know in life you have to have a dream. And one of the dreams is our desire and the market’s need to have more access at retail to alternative investment products," Stephen Schwarzman, chairman and CEO of The Blackstone Group, told analysts on the company’s earnings call in January.

Intermediaries are central to this strategy, whether it involves working with international private banks or wealth managers in different geographies. Blackstone is also extending its focus from high net worth individuals (HNWIs) to the mass affluent, targeting independent broker dealers. The firm is said to offer week-long, university-style education programs so that advisors can better understand its private equity, real estate, hedge fund and credit products.

Will these educational efforts one day include sessions on a dedicated Blackstone platform through which advisors can research pooled investment products, make commitments, and track investments through to redemption? It is unclear to what extent alternatives could see disintermediation, but there are already technology providers working on more cost efficient solutions for HNWI fundraising.

Privatemarket.IO was established last year in Hong Kong as a B2B platform for accessing, analyzing and executing primary and secondary market transactions online. Commitments from family offices, private banks or independent financial advisors (IFAs) are funneled into an Ireland-based feeder vehicle, which invests in the fund. “We have a huge advantage in terms of pricing, given how much our technology allows us to lower the costs of setting up a vehicle and managing it,” says Loic Engelhard, founder & CEO of Privatemarket.IO.

The funds available on the platform are Asia-focused and most of the participating investors are European. At present, execution happens partly offline, using electronic signatures, but the goal is to digitize the entire process through distributed ledger technology and smart contracts. “We will build the business on that because I am 100% convinced it’s where the industry is going,” Engelhard adds.

Privatemarket.IO has competitors, including US-based iCapital Network, which has received backing from a string of placement agents that also serve as strategic partners. To some in the industry, it is only a matter of time before global alternatives managers develop their own versions of these products.

“As the market matures you will see things like iCapital continue to grow, particularly targeting capital from the US managed by individual IFAs,” says Michael Henningsen, a partner at First Avenue, which is one of iCapital’s backers. “Having platforms on which IFAs can register and pick funds for their clients they like is the Holy Grail very attractive for global PE firms given how scalable it has the potential to be.”

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Fundraising
• GPs
• Advisory
• Buyout
• LPs
• Asia
• China
• Noah Holdings
• CreditEase
• HSBC
• Standard Chartered
• The Blackstone Group