Asian outposts: LPs see value in a local presence

When J.P. Gan announced his departure from Qiming Venture Partners in July, Edward Grefenstette, president and CIO of The Dietrich Foundation, was among those who put in a call for an update. This was followed by dinner in Shanghai to discuss the next iteration of his career as founder of Ince Capital Partners. “It gave me the chance to look a longtime friend in the eye and talk about his remaining goals and motivations from here,” Grefenstette, a longstanding Qiming LP, explains. “For me, that was extremely important for building the high conviction to move forward.”

The Dietrich Foundation is not huge by US institutional investor standards, with total assets recently passing $1 billion, but it has been active in Asia for 13 years and has built up an abnormally high allocation to the region. More than 40% of the foundation’s book is committed to venture and growth managers across Asia. China alone accounts for 30%. Ince is the most recent addition to the GP roster.

There is an ongoing debate within The Dietrich Foundation as to whether its Asian exposure is substantial enough to warrant a permanent presence in the region. To date, they have concluded that flying in and flying out is the optimal solution. There are three reasons for this.

First, the team believes its current information flow, drawn from phone calls and research trips, is not diminished by the lack of boots on the ground. Second, it values the ability to pass on opportunities and look elsewhere. There’s a concern that a presence in Asia would create a bias towards Asia, notwithstanding best efforts to be independent-minded and thoughtful. Third, Grefenstette laughs and argues there is a reputational advantage – a novelty even – to “being these crazy people from Pittsburgh that fly in all the time.” An office in the region might take the edge off this effect.

Few endowments and foundations have a US presence outside of their home cities, let alone in Asia. And for institutional investors of all stripes, the region remains the final frontier for private markets – somewhere they profess a desire to be more active yet are not active enough to justify setting up shop. Canadian pension funds are leading the way, with seven groups now occupying premises across Hong Kong, Singapore, Sydney, and Mumbai. Teacher Retirement System of Texas (TRS) is expected to follow suit, but it is considered the exception to the rule among US pension plans.

“A certain percentage allocation should necessitate a presence on the ground. If you believe it is important to make good investments, and if your portfolio is of any meaningful size, it should follow that the cost benefit of siting people locally is worth it,” says Peter Keehn, global head of private equity at Allstate. “But it’s never that simple. Every organization struggles with cost, especially in an era where cost of ownership in public investment management keeps going down and the cost of ownership in private equity remains stubbornly high.”

Setting up shop

The sands may shift as macroeconomic tides pull towards Asia – the region is expected to account for over half of global GDP within five years – but these trends are difficult to gauge. Industry participants observe it can be difficult to persuade a US LP to move from zero or negligible Asia allocation to a more meaningful percentage, even when there is a recognition that the big picture is changing and that a diversified portfolio is desirable. From thousands of miles away, questions about the size of the PE opportunity, the depth of the manager universe, and the length of track records can become deterrents.

A more immediate driver is arguably rising competition for co-investment. This does not apply to all LPs – co-investment is not a big part of The Dietrich Foundation’s program, for example – but a growing number are looking to bring more assets in-house. It is difficult to have the nimbleness to respond to opportunities, and the information to know whether they are worth pursuing, without a local presence. Moreover, when demand for co-investment exceeds supply, the GP will likely choose to work with partners it feels can bring the most to a deal.

“It’s fair to say that more LPs are focused on co-investment,” says Frank Su, head of private equity at Canada Pension Plan Investment Board (CPPIB). “We don’t want to be a burden to our GPs, we want them to focus on securing the best deals. Getting co-investment comes down to how you think of your value-add as an LP. It’s not just about making the decision in an efficient way and asking the right questions. It’s a about how you see your relationship with the GP.”

CPPIB was the first Canadian pension plan to put down roots in Asia, opening its Hong Kong office in 2008. There are now bases in Mumbai and Sydney as well. OPTrust arrived in Sydney in 2012 and Ontario Teachers’ Pension Plan (OTPP) set up in Hong Kong the following year. They have since been joined by Manulife, Caisse de dépôt et placement du Québec (CDPQ), Ontario Municipal Employees Retirement System (OMERS), and the Public Sector Pension Investment Board (PSP).

A scattering of other non-Asian institutional investors has a presence in Asia, ranging from the Church Pension Fund to APG Asset Management to Metlife. “I expect to see more LPs establish offices in Asia,” says Wai Leng Leong, head of strategic partnerships in Asia at CDPQ. “We talk a lot about being more international, looking for more diversification, looking for returns in growth markets. It is a challenge covering Asia from Canada, the US or Europe.”

The functions performed by these offices vary based on mandate and length of tenure in the region. The proposed Singapore office for TRS would be staffed by a team of four covering private investments and public securities trading. The goal is to replicate what has been achieved in London, where the establishment of a local office uncovered a stream of potential deal flow that was previously overlooked. However, CIO Jerry Albright told an investment committee meeting in July that Asia would take longer to come to fruition. Grasping the dynamics and culture of local markets must happen first.

TRS only started investing in Asian private equity in the mid-2000s and has built up direct exposure to a handful of GPs. Co-investment activity is limited. While the pension plan is building out its PE team with a view to taking part in more direct deals, Eric Lang, senior managing director of external private markets, demurs when asked if an Asia presence would necessarily result in more Asia-based activity.

“One thing it does mean – assuming we do open the office – is we will be closer to the market, closer to the deals, closer to our general partners. Hopefully, this will make us better investors. I wouldn’t say there is a mandate that we must do a certain number of principal transactions in Asia because we have an office there but that will evolve over time with more deal flow, as it has in London. Even then, we aren’t doing deals for the sake of it,” he says.

A matter of scale

CPPIB also built out its Asia operation in a measured fashion. The local team was small and focused solely on fund investments, establishing a portfolio that now features about 20 GPs and funds large enough to accommodate a minimum check size of $75 million. The first co-investment subsequent to the Hong Kong office opening came in 2011. Since then, the team has grown to 30, of which two-thirds are primarily focused on co-investment. They have leveraged those GP relationships to the extent that approximately 40% of private equity assets are in direct deals.

With CPPIB looking to increase the Asia share of its portfolio across all asset classes from one quarter to one third – and the overall fund projected to surpass C$1 trillion ($760 billion) in 15 years, up from C$392 billion in 2019 – the absolute amount of capital deployed in the region, across funds and co-investment, will surely grow. The pension plan has committed as little as $30 million and as much as $1.3 billion to a co-investment. Larger co-underwritten transactions, where CPPIB works in partnership with the GP from day one, are likely to feature more heavily in the future.

“We still feel partnerships are the key pillar for this business. I have 30-plus people and two-thirds are direct, but when you look at the teams working for our GPs, they easily outnumber us,” says Su. “Partners cumulatively have all the resources on the ground and can discover interesting opportunities.”

CPPIB’s approach is a function of its size and expected pace of deployment. Other Canadian plans are neither so GP-centric nor broad in scope. With C$309 billion in assets at the end of last year, CDPQ is of comparable size but addresses Asia in an apparently more concentrated fashion. Its has less headcount – there “more than 10 people” in the region – and seeks to develop opportunities across asset classes through the cultivation of strategic relationships with corporate, financial and government partners.

OPTrust, meanwhile, is at the other end of the spectrum. The C$25.9 billion pension plan only started its private markets program in 2005 but it already accounts for nearly 30% of the portfolio. There is a team of five in Sydney, covering private equity and infrastructure, and they are responsible for only four GP relationships in the region, two pan-Asian and two country-focused. The split between fund and direct investments is 50-50, with OPTrust compensating for its limited bandwidth by focusing on direct deals in Australia, which are more readily accessible. Check sizes are in the C$30-100 million range.

It doesn’t necessarily invest alongside portfolio GPs; to date, only a couple of deals have followed this structure, with a further three or four handled directly. There is a preference for long-dated investments – perhaps longer than most GPs would like – at the nexus of private equity and infrastructure. 

“We wanted to have the ability to invest from low-risk core infrastructure to value-added infrastructure and across the private equity spectrum,” says Stan Kolenc, a managing director in the private markets group. “Without the Sydney office, several things we’ve done would not have been done. First, from a sourcing perspective, we wouldn’t have seen them. Second, from an execution and management perspective because we wouldn’t take the positions without being on the ground.”

He points to SkyBus, which was acquired in 2014 in partnership with Trent Peterson, formerly of Catalyst Investment Managers. At the time, the company had a few years left on a contract to provide shuttle services to Melbourne airport. The new owners built out the platform, adding airport services in other cities and buying one of Australia’s largest public bus operators. Crucially, short-term contracts were replaced with longer duration ones, creating a stable income stream model more akin to infrastructure than PE. OPTrust bought out Peterson last year and has no immediate plans to sell.

Doubling down

For LPs contemplating an office in Asia, two of the most immediate considerations are what do they want to achieve and how much of the market can they feasibly cover. Is it a geographically broad funds-centric program with opportunistic co-investment, a narrow strategy that goes deep on direct deals, or something in between? Moreover, does the LP have the budget and risk appetite to make it work?

“A major reason for the lack of local offices is cost and resources,” says Doug Coulter, a partner at fund-of-funds LGT Capital Partners. “It’s not just opening the office, which can be expensive, but staffing up properly for the long term. You need a certain amount of scale. Even if you hire six people and put them in Hong Kong or Singapore, depending on what you want to do, that could be subscale. Some of the Canadian groups have invested in large teams and established secondary offices in key cities. If you aren’t willing to make that kind of commitment, is it worth the bother?”

When an LP does make that kind of commitment, the impact can be transformative – and not just in terms of fee savings. A GP able to tap a slate of seasoned co-underwriters can pursue deals that far outstrip the capacity of its fund. For example, had BGH Capital’s bid last year for Australia-based Healthscope succeeded, 90% of the capital would have come from LPs, sources say. OTPP and CPPIB were two of four co-investors ready to cover three-quarters of a A$2 billion ($1.4 billion) equity check. BGH would have underwritten the remaining A$500 million and syndicated over half of it to other LPs.

According to private equity executives in Asia, some LPs have become far more accomplished co-investors over the last few years as they have accumulated experience and local resources. One manager recalls losing out on a deal because so much of a six-week due diligence was spent getting the co-investors up to speed that they simply ran out of time. Now, co-underwriters are deeply involved from the outset, dispatching people for site visits at short notice and responding rapidly to queries.

It is not just that the investment professionals involved are based in the region and arrive with existing knowledge of the market and perhaps the target company as well, large LPs are able to bring their global resources to bear. This might be a sector team based in the group’s home market or a set of dealmakers with relevant experience. “I’m working on a deal right now and one of my LPs had done a similar deal in another part of the world,” says one GP. “They know a lot about it and the investment was successful, so we have leveraged their expertise and had those people involved in the process.”

Asked if the presence of multiple co-underwriters on a deal could be more of a hindrance than a help, industry sources say the real challenge is ensuring none of them goes hungry – which may mean limiting how many get into the fund in the first place. If co-investment is skewed in favor of one group over the course of a fund life, securing re-ups from its like-minded peers becomes that much harder. Indeed, there have been instances in which a single LP has offered to make a large blind pool commitment, on the condition that several typical rivals for co-investment are excluded.

Cultural questions

British Columbia Investment Management (BCI) stands out as a Canadian pension plan that has made progress on co-investment without the support of an Asian office. Jim Pittman was recruited from PSP three years ago with a brief to bring more direct exposure to the PE program. The Asia share of this C$13 billion portfolio has risen from single digits to around 15%, according to Pittman, through large commitments to pan-regional funds and co-investment. 

The fund strategy comprises two strands. BCI writes large checks in the $100-350 million range for pan-Asian funds above $3.5 billion. There are currently four main relationships of this nature out of only nine globally. The pension fund also has a separately managed account with Asia Alternatives through which it makes smaller commitments to growth and emerging managers in the region. 

Managers in the first strand deliver significant co-investment opportunities – the largest BCI has put into a single deal is C$160 million – so far mostly in developed markets like Korea, Japan and Australia. Additional deal flow comes through the Asia Alternatives channel, with the team in Victoria handling anything over $50 million directly. Since 2016, the team has grown from seven to 37, of which 24 are investment professionals. Five of them are dedicated to funds and the rest cover co-investment.

“You must find good talent for investing, but you can start small, doing $25-50 million co-investments to get some traction,” Pittman says. “You need specific decision-making processes and you need to be able to spend money on due diligence and flying to locations. That is critical to getting yourself set up. We are fortunate in Canada that initially OTPP, and subsequently OMERS and others, have paved the way. The rest of us can borrow from that, tweak it, and figure out how we can best do it.”

For larger co-investments in Asia, BCI will receive a call and then screen a deal over a few days based on the information submitted by the GP. Investment professionals could be dispatched to the target market on the fourth day or thereafter. Up to four or five people could work on a single deal, though not all these will travel. Any decisions are taken at the weekly investment committee meeting.

There have been three co-investments in the region so far, two co-underwritten transactions and one downstream syndication. Despite a preference for co-underwriting, BCI is not yet ready to open an office in Asia, or anywhere outside Victoria. The shift in private equity strategy happened barely three years ago and having everyone in a single location means they can climb the learning curve faster and in step with each other. A cohesive investment culture will not be risked for the sake of convenience.

Allstate’s Keehn endorses this approach. “It’s not just the cost and the logistics. Integrating a satellite office with the home office – where group decision making happens, and the consequences of those decisions are very good – is hard to get right. You need the right cultural fit,” he says. “The cultural fit of a Western organization can be as hard to explain to people you try to hire [in Asia] as the reverse.”

This may explain why the hiring processes for some senior positions with LPs in Asia have seemed so protracted. There is a general desire for balance within the nascent team, which means a combination of local hires and investment professionals seconded from head office. Once they are in place, it takes time to establish trust with an investment committee on the other side of the world, so recruiting well in the first instance is infinitely preferable to a series of rebuilds. 

“They are very long-term investors; they are very team-oriented; they are methodical,” says Michael Di Cicco, a partner at executive search firm Heidrick & Struggles. “They will take their time and make sure they have the right people – and once they have them, they like to keep them. There are people at some of these organizations I’ve known for years and they haven’t moved.”

Gradual evolution

It could be argued that everything these groups do in the region should be viewed through a lens of incrementalism. Opinions vary as to whether – and in what timeframe – co-investing alongside GPs evolves into competing with GPs for deals. It is a reasonably established trend in the infrastructure space in Asia and some managers are wary of it bleeding into private equity. In this context, OPTrust’s progress on direct infrastructure-private equity crossover deals should come as no surprise.

CPPIB, which has gone solo on a few private equity investments in North America, already describes co-underwriting as a bilateral discussion between GP and LP. “Oftentimes, when we co-underwrite, we know the deal ourselves and we are very proactive in terms of teaming up with our partners and we are very involved on diligence and post-transaction asset management work,” says Su. “We work with our partners and build relationships with key stakeholders in the market, so we know what is going on and we can identify interesting opportunities.”

However, this is not so much supplanting the GP as addressing the reality that both parties have boots on the ground and large-ticket transactions are sometimes highly visible. Execution is still a joint exercise. Industry sources could name only one recent deal in which the balance power meaningfully swung towards the LP: Abu Dhabi Investment Authority is said to have done the legwork on a $1.2 billion investment in India’s UPL Corporation and then brought in TPG Capital as a value-added partner.

Situations of this nature are expected to remain a rarity. “We will see more of these direct deals, not dramatically more, but incremental increases,” says BCI’s Pittman. “You have to think of it as a subset. These are going to be large, stable assets with strong management teams, possibly already owned by a GP and fixed up or improved. They will not be minority or high-risk deals that require a lot of turnaround. Unless you have a large team, that’s hard to do.”

As for other institutional investors establishing platforms in the region that could ultimately serve as a platform for these activities, the wait might be even longer. Moving from a passive to an active mandate is inconceivable for some pension funds in their home markets, let alone as far afield as Asia. 

“The more sophisticated LPs become, the more the organization and the stakeholders understand the necessity of having professional management over the assets,” says Andy Hayes, a managing director a placement agent First Avenue and previously an investment officer at Oregon State Treasury. “But in the case of Asia, you are talking about small allocations in a global private equity portfolio and limited resources, which makes it hard to consider things like setting up offices and co-investing.”   

 

SIDEBAR: Money matters    

Recruitment is high on the agenda for any institutional investor looking to build a beachhead in Asia. Headhunters say they are seeing robust demand not only from new arrivals but also from established players that have tested the water and are now looking to increase headcount.

“We are seeing a lot more activity and we are seeing more broadly – private equity, real estate, infrastructure. It’s broader across the region as well and I think we’ll see more of that,” says Michael Di Cicco, a partner at Heidrick & Struggles. “Pension funds that have the scale and the interest in emerging markets are really starting to build on the ground here.”

One of the challenges they face is compensation. The decision taken some years ago to separate Canada’s pension plans from government and set them up as separate trustee accounts was groundbreaking in terms of private markets strategy. While investment officers at US pensions are essentially government employees – with salaries that reflect this status – the Canadians can determine what level of compensation is required to deliver the returns expected from different asset classes. 

Even so, the focus on co-investment involves hiring people with experience doing direct deals, which can mean LPs are competing with GPs for talent. To what extent can they match the carried interest paid by private equity firms? 

There are numerous ways to sweeten the deal. According to industry sources, some sovereign wealth funds simply offer a very attractive base and bonus package with substantial benefits on top. Canadian pension plans tend to offer a tranche of compensation that is performance-based but far removed from eat-what-you-kill. It is comparable to the firm-wide carry model, but also incorporates a range of other metrics designed to capture an individual’s overall contribution to the platform.

For example, the Public Sector Pension Investment Board (PSP) says its compensation framework is market driven yet subject to discretion at every level so as “to ensure behaviors are aligned with PSP Investments’ vision and values.” For senior vice presidents, the bonus has a target size of 350% of base salary and is half cash payout and half deferred award. Of the latter, 40% is paid out after three years, conditional on performance, and 60% vests in equal portions over the course of three years.

Canada Pension Plan Investment Board (CPPIB) takes a similar approach. Compensation comprises base and bonus tranches – with a portion of the bonus deferred over three years – and the total is adjusted by a performance multiplier. The multiplier considers total fund performance over the past five years, department and group performance over annual and multi-year periods, and individual performance, which is based on customized objectives.

Salaries are described as attractive by industry standards but joining a pension fund is not just a matter of money. Di Cicco notes that these organizations are collegial in nature and not necessarily suited to “the great shining light all-star dealmaker,” so the motivating factors tend to be broader.

Frank Su, head of private equity at CPPIB, adds: “People don’t come to our platform solely for compensation and I don’t think we are in a position to compete with GPs on that. It is really about the total package. We are a global organization with broad exposure and a long-term focus. An additional benefit is we don’t have to raise capital, which means professionals can focus on their work: investing, managing the portfolio, creating value.”   

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• Topics
• LPs
• Fundraising
• Investments
• GPs
• Asia
• CPPIB
• OTPP
• Caisse de depot et placement du Quebec (CDPQ)
• Ontario Municipal Employees Retirement Scheme
• Teachers Retirement System of Texas
• PSP Investments
• British Columbia Investment Management (BCI)
• OPTrust