Japan benchmarking: Body of evidence

The benchmark offers a generally positive snapshot of Australian private equity: local PE and VC managers had comfortably outperformed the ASX 300 Index across every time increment (one-year, three years, five years, 10 years, and 15 years) in local currency terms, as of September 2017. They had also bettered the Asia-Pacific Developed Private Equity & Venture Capital Index on all apart from a one-year basis, although the numbers lose some of their shine when returns are converted into US dollars.

This performance analysis is provided by Cambridge Associates, using data collected under an agreement with the Australian Private Equity & Venture Capital Association (AVCAL). The benchmark serves two purposes: promoting an industry that is still viewed skeptically, to varying degrees, by the media, policymakers, and public; and supporting fundraising efforts by local managers. Now Japan wants a benchmark of its own to address the latter issue.

"At the moment, nobody releases data," says Kazuhiro Yamada, chairman of the Japan Private Equity Association (JPEA). "It's a very strange situation, especially for some global LPs that find it hard to make a judgment as to whether target GPs have performed better or worse than the market. That's the main reason for this initiative."

The initiative is still in its early stages, although it has been discussed intermittently for more than a decade. The JPEA must first persuade its 32 full members – which range from Bain Capital to Iwakaze Capital – to vote in favor of introducing a benchmarking system. Then the challenge becomes ensuring they supply a consistent stream of usable data to the third-party tasked with crunching the numbers. 

This is no easy task in a country regarded by many offshore LPs as a black box. "There's a huge problem getting data out of Japan, everything is non-transparent," observes one Asia-based executive with a global fund-of-funds. Vish Ramaswami, a managing director with Cambridge, adds: "In my experience of Asian managers, there is a reluctance to share data with a third party. It might be the same in Japan."

Who's money?

If 2017 is anything to go by, Japanese mid-market managers are having no difficulty raising money. More than $2.5 billion was committed to buyout funds last year – the most since before the global financial crisis – with nine final closes. However, about two-thirds of those managers relied on domestic LPs for most of their capital as financial institutions came to the fore. 

The question at the back of everyone's minds is are these local investors here for the long term. Building up a following among offshore LPs is seen as a sensible strategic move. "Many local banks have been putting money into private equity but it's not certain they will re-up next time," says Kazushige Kobayashi, a managing director at Capital Dynamics. "As a result, GPs want to have more foreign capital next time around."

This coincides with rising foreign LP interest in Japan, driven by anecdotal evidence of strong performance by several managers as well as rising middle-market deal flow. It represents an about-turn from the situation as recently as six years ago when investor sentiment was weak, and some local managers struggled even to find international placement agents to help them raise capital. But then, as now, an inability to track and compare performance was also a problem.

"I've been hearing comments for some years that because of the lack of a benchmark it is hard to justify commitments to Japanese funds at the investment committee," says Greg Hara, CEO of J-Star. "I know many of the fund-of-funds are collecting data but having a benchmark may prompt a wider variety of institutional investors to consider putting in money."

At present, Cambridge does not publish Japan-specific benchmarks, in part due to a lack of data. The basic requirement for the formulation of any benchmark is copies of the financial statements GPs send to LPs detailing the cash flows in and out of a fund and the net asset value (NAV) as of the most recent reporting period. This is considered sufficient to calculate IRRs, TVPIs (total value to paid-in), and DPIs (distributed to paid-in).

To take that forward and produce a median return and upper and lower quartile returns, there must be at least eight funds in a given vintage year. Anything lower and it becomes obvious to the sophisticated reader which funds have been sampled.  

The Australia benchmark is based on data compiled from 71 private equity and 29 venture capital funds, including fully liquidated partnerships, formed between 1997 and 2016. Upper and lower quartile information is available for four of those years, the only vintages featuring nine or more funds. Cambridge is still able to produce an average or pooled return for the entire industry in slim vintages, but that becomes unworkable with fewer than three funds.

"It is important that we encourage and invite all of our GP members to participate. If it's a small number, then it won't be a strong dataset," says JPEA's Yamada. As it stands, the association has asked its core members to submit basic fund-level performance data and it hopes the rest will eventually follow suit. 

In an ideal world, the disclosures would go further than that. Most GPs in Western markets provide portfolio-level information in addition to fund financial statements. This serves to deepen the benchmark and allow further analysis of investment returns by sector or by size of company. And in the absence of fund-level data, comparisons can sometimes be made between two funds using portfolio company information. 

Japanese managers face two major obstacles even to meet the minimum level of disclosure, one practical and the other philosophical. The first involves incongruities between Japanese and international reporting protocols and accounting systems, which become apparent when studying the performance of managers that don't have international LPs or run yen-denominated funds as well as US dollar vehicles. Valuation is arguably the most divisive issue.

Whereas the International Financial Reporting Standards (IFRS) permit equity instruments to be measured using fair value, the equivalent Japanese protocols insist on measurement at cost. As such, appreciation or depreciation in the value of an asset during a private equity firm's holding period would not be reflected in performance data. Calculations would have to be remade for use in an international benchmark.

"Because the valuation of unrealized investments is very low or conservative, the data often don't look as good as in foreign markets," says Kobayashi of Capital Dynamics. "There have been discussions about changing the accounting standard, but that would take time."

Uncertainty reins

The second obstacle is that reluctance to share information. One manager who spoke to AVCJ expressed concerns about data potentially falling into the hands of competitors and claimed the absence of a benchmark is not a "deal killer" for most LPs. At the same time, there is a recognition that as more foreign investors look at Japan, it is better to have a benchmark than not have one.

This uncertainty extends to what the analysis might expose as well. Some private equity firms in Japan have outperformed by regional standards, but there are also players that have come into the industry with little experience and are trying to replicate strategies employed by established GPs. Should they fail to deliver, the average return for the entire market would suffer.

Indeed, there are no guarantees that a benchmarking system would make any set of managers look better, rather it promises to show them in clearer light – and LPs appreciate this. "Even if the average is not so good, it helps in manager selection," says Cambridge's Ramaswami. "LPs can calibrate how well their manager has done against the market and understand what sort of manager they should be backing and what they should be looking for from top-quartile managers."

There are likely to be teething problems and investors will not judge every GP favorably once they have the relevant information at their fingertips. Nevertheless, just having the ability to judge should ultimately benefit the industry as certain groups find they can attract commitments that are not only larger in size than before but also come from a higher quality of LP.

"Some domestic PE firms don't have mark-to-market valuations, some are hesitant about submitting data," says JPEA's Yamada. "However, everyone understands this is an important initiative to expand the Japanese PE market."   

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• Topics
• North Asia
• Performance
• GPs
• Japan
• Japan Private Equity Association (JPEA)
• J-Star
• Capital Dynamics