PE firms hedge their bets

Is it enough to be a pure-play private equity or hedge fund in Asia? A handful of investment firms think not. The likes of The Rohatyn Group, D.E. Shaw and TPG Capital have long recognized the shortcomings of focusing on one particular asset class and adjusted their investment strategies to offer both hedge fund and private equity strategies under one roof. Other Asia-based managers could be about to follow suit.

Convergence is perhaps to be more expected where hedge funds are concerned, given that their industry that has suffered stunted growth over the last few years. Indeed, Hong Kong-based Senrigan Capital, in which The Blackstone Group upped its investment by $50 million last month, is one of just five or six hedge funds in Asia to amass assets worth $1 billion or more since 2008.

Asia fund returns have also been lackluster, particularly those for equity long-short strategies, which ended 2011 down 13.7%. The realization that they can't consistently generate the 15-20% returns their investors demand has prompted several funds to branch into other areas.

Crossing boundaries

Symphony Financial Partners is one example of this. Though closer in nature to a hedge fund than a private equity player, the Japan-focused firm runs a hybrid model that crosses into traditional PE territory on a number of levels. Symphony invests in publicly-listed Japanese firms and, like private equity, prefers to take sizable stakes in these companies - its record so far is a 50% equity stake. It also offers its investors limited liquidity, although rather than being locked in for a 10-year fund lifespan, LPs have a mere 2-3 year lock-up.

According to David Baran, Symphony's co-CEO, this strategy makes sense because of the importance of relationships in Asia, and in Japan in particular. Adopting a typical finance-orientated hedge fund approach can often leave managers out in the cold.

"It's more about influencing and building trust and creating a relationship, rather than looking at the pure economics and deciding what to do that way," he explains. "You have to be adaptive and work out how to get around it. You have to work in collaboration with management. For regular hedge funds - not ourselves - it's almost an impossible task."

For global PE firms that are now publicly listed, there is also a broader imperative: diversifying their business away from pure corporate private equity, which can generate inconsistent income streams, and seeking greater exposure to more liquid public equities. In June, KKR agreed to buy Prisma Capital Partners, a US-based hedge fund-of-funds, while last year The Carlyle Group bought a 55% stake in Emerging Sovereign Group, a US-based emerging markets-focused hedge fund manager.

Baran argues that we could also start to see Asian PE firms attempting to evolve into broader-base asset managers, given the particular opportunities available in the region.

"Private equity managers are going to have to change their stripes a little bit if they can. The conditions within Asia are just different from the US and Europe and you just can't transport your strategy here and think it's going to work," he says. "They will have to become more flexible in how they establish and unwind positions when they're working into a situation."

As more firms make efforts to tap Chinese LPs, increasing pressure to offer greater liquidity could also cause some to offer shorter fund lock-periods.

In addition to asset managers expanding their offerings into each other's territories, another potential way for PE and hedge funds to collaborate is through co-investment. Blackstone's increased exposure to Senrigan Capital - which followed its $100 million seeding of the firm of 2009 and a later investment of $50 million - gained the asset manager the right to co-invest with Senrigan on a number of projects. Though Blackstone's investment was made via its fund-of-funds unit, there is speculation that its PE vehicles could invest alongside the hedge fund, which could prompt other PE shops to seek similar opportunities.

Evidence of this happening so far is thin on the ground, however, with cornerstone investments and PIPE deals constituting the occasional exception to this.

In April, PAG and D.E. Shaw - both of which run both private equity and hedge fund vehicles - stood alongside each other as cornerstones in the IPO of Haitong Securities, China's second-biggest brokerage by assets. In March, both hybrid PE-hedge fund Hillhouse Capital Management and Och-Ziff Capital Management bought $80 million of shares in the IPO of Far East Horizon. And last November, MBK Partners invested $100 million in the IPO of New China Life Insurance, also alongside D.E. Shaw.

"In Europe and the US there have been a number of hedge funds that have for some time been successful in pursuing M&A strategies involving both public and private companies," says Simon Weller, a Hong Kong-based corporate partner at Freshfields. "Out here in Asia, however, we haven't seen as much in the way of hedge fund activity on the M&A front. This may be partly because private equity investors in the region are not short of dry powder and so there isn't the funding gap that hedge funds might otherwise step into."

Access to expertise

Another factor is that hedge funds traditionally operate as smaller operations than PE firms, so they are unlikely to have invested in building sufficient teams, nor have the expertise needed for successfully sourcing and executing private transactions.

A need to access this manpower and expertise could conversely be what causes hedge funds to seek co-investments with private equity. Despite being a firm which is heavily focused on China's mid-market space - and rarely entering into listed deals - Lunar Capital has received numerous approaches from hedge funds. Partner Michelle Leung believes that this is partly motivated by the difficulties hedge funds experience, particularly those based in Hong Kong or New York, in securing high quality due diligence on Chinese companies.

"Hedge funds would benefit from being able to tap into the resources that a PE fund has, being local, on-the-ground and operationally-focused," she says. "This is much more the case in this market than any other, because in a more mature market you could rely on publically available information for your due diligence."

A desire to attain private equity-level due diligence in Asia may offer one explanation for The Rohatyn Group's (TRG) acquisition of Singapore-based PE infrastructure investorCapAsia earlier this year. TRG now holds a 60% stake in CapAsia, having bought the shareholding from CIMB, Malaysia's second-largest bank.

"Hedge fund managers have built platforms that are robust in terms of the infrastructure and processes, and feel that in order to grow as a fund manager, they need to add other asset classes that would benefit from the economies of scale of using the structures and market reputation that they've built," adds Johan Bastin, CEO of CapAsia.

Since going under the TRG umbrella, CapAsia has been able to secure commitments for its latest fund from a number of TRG's own investors and now shares key functions such compliance, IT and risk management services with its new parent. In 2011, TRG also acquired Asia-focused real estate investor ARCH Capital.

Beyond co-investment, or out-and-out acquisition of a private equity or hedge fund, a further way in which these entities are working together is in sharing advice and ideas. Lunar Capital has done this on numerous occasions, after having been approached directly by a hedge fund or when LPs that have invested in hedge funds ask for views on specific sectors.

"If some of our LPs had invested in the listed sports apparel space in China, they'd want us to help with due diligence on the company, or offer our views on the retail sector in China because of our investment in our baby clothing business, Yeehoo," says Leung. "We haven't monetized this by investing in public securities ourselves but the skillset seems to be quite valuable and applicable to a hedge fund or an investor who's looking at the more liquid space."

Diverging strategies?

Though some predict that as the market matures in Asia, each asset class will focus more on their own mandates and the blurred lines and cross-investing between them will lessen, there's a consensus that the future of multi-strategy fund managers will ultimately depend on LP sentiment. If investors do end up favoring the collaborative approach - possibly seeing it as an advantage to have more managers looking at the same sectors in different ways - then the hybrid fund managers could find that they've hit on something special.

How this strategy will be exploited down the line remains to be seen, but CapAsia'sBastin believes that the logical next step would be for those "one-stop shops" to sell their capabilities as a fund manager via an overlay fund - combining liquidity and long-term returns.

"If they have sufficient scale, a fund manager with multiple strategies may market an overlay fund that could invest in private equity, infrastructure or hedge funds so that investors don't have to make this choice," he predicts. "That would attract smaller pension funds, family offices and high-net-worth individuals."

SIDEBAR: What do LPs think?

Whether more Asia-focused private equity and hedge funds enter into alliances as the industry matures depends heavily on LP sentiment. Fund managers are far from aligned at present in their perception of what LPs think, however.

"Investors are looking for a hedge fund. They're not looking for a crossover," David Baran, co-CEO at Japan-focused Symphony Financial Partners, tells AVCJ. "Conversely, the PE investors - foundations, endowments, universities - are looking for PE guys."

For that reason Baran prefers not "cubby-hole" Symphony's investment strategy into either private equity or hedging, as he believes that trying to market a hybrid vehicle still presents a challenge.

Other industry participants, though, have noted a more receptive response from LPs. According to Michelle Leung, a partner at Lunar Capital, most investors are open-minded about funds with different strategies. As long as the managers are good fiduciaries, with good governance and the ability to manage conflict, many consider multi-strategy funds in a positive light.

"As long as the lines are clearly delineated, having cross-investing between funds or having one manager looking at different strategies is probably a good thing," she says. "It really depends on how good the managers are."

Given the disagreement, it may be that the LP opinion depends on the type of investors funds are dealing with. Some institutional investors are likely to show more resistance towards managers offering more than one strategy due to the highly compartmentalized nature of their asset allocation strategies.

Investors such as the California Public Employees' Retirement System (CalPERS), for example, will almost certainly have infrastructure defined as a separate asset class to private equity and hedge funds and will have dedicated teams for each one. They are unlikely to be impressed by a fund manager offering more than multiple products.

"Investors like family offices and high-net-worth individuals, however, might be interested to build a relationship with a firm that offers different investment strategies and asset classes," points out Johan Bastin, CEO of infrastructure fund manager CapAsia.

Asian institutions - such as Government of Singapore Investment Corporation and Temasek - which have started to pursue a more opportunistic and less ratio-based style of investing, could also find their interest piqued.

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• Topics
• GPs
• LPs
• Greater China
• Southeast Asia
• South Asia
• North Asia
• Financing
• Hedge funds
• GPs
• LPs
• China
• Southeast Asia
• Japan
• Co-investment
• Lunar Capital Management
• Och-Ziff Capital Management
• D. E. Shaw