Indian LPs: Emerging or defunct?

Multiples Alternative Asset Management stands out within Indian private equity. Not only is the firm managed by Renuka Ramnath - the nation's so-called queen of private equity, who spun out from ICICI Venture in 2009 - but last November, it closed its first fund on target at INR20 billion ($450 million), having attracted contributions from both foreign and local LPs. Domestic participants include Andhra Bank, Indian Overseas Bank, Life Insurance Corporation of India, Punjab National Bank and the Small Industries Development Bank of India.

Few others have achieved this feat. Reliance Private Equity raised $220 million from local institutional investors including Industrial Development Bank of India and high-net-worth individuals (HNWIs); Aditya Birla also tapped local source for the INR6.75 billion first close of its debut fund; and TVS Capital Funds became the first major PE firm to raise an INR6 billion all-rupee vehicle in 2008.

Further examples of Indian GPs attracting capital from homegrown investors are conspicuous by their absence.

Limited base

The reason for this dearth of local capital is almost entirely down to the unsympathetic regulatory framework which exists with relation to asset class' biggest potential contributors. While organizations of the size and scale of California Public Employees' Retirement System (CalPERS) do exist in India, their investment strategies are rigorously dictated by their owner - the government.

The Indian state controls all of country's largest pension funds, banks and insurance companies, and thereby ensures that no more than 10% of their assets under management can be invested in equities of any kind. Things are even tighter for insurance companies, such as Life Insurance Corporation of India (LICI), the country's largest, as their limit is 5%.

"Even a lot of that 5% is forcibly taken up in public sector undertakings with large government-owned companies like Oil and Natural Gas Corporation (ONGC)," says Vikram Utamsingh, head of transactions and restructuring for KPMG India. "When the government wants to raise money by selling off 5% of ONGC, typically the LICI will come along and pick up 3% of that."

Pension funds, meanwhile, are only permitted to invest in low-risk products such as government bonds and fixed-return instruments. The end-users of these funds - India's retirees - play a big part in the thinking behind this policy. The Provident Fund, for example, which receives contributions from all members of India's workforce, guarantees pensioners an 8% return on their payments.

"The government can't afford under any circumstances to be in a situation where the Provident Fund makes investment in equity which don't give the return that is required to make the pension pay-out when it falls due," explains Utamsingh. "So the government will take zero risk on that."

Air miles

As a result, managers of Indian private equity funds - which in the future stand to make far superior returns to credit assets - have little choice but to target overseas LPs for capital.

Indeed, as the rules governing local institutions have been in place since before the advent of the asset class in India, even the nation's biggest PE players have had to set their sights 100% abroad from the outset: ChrysCapital, which is expected to close its $500 million sixth fund any day now, and Everstone Capital, which manages assets worth more than $1.6 billion, haven't raised a rupee of domestic money between them.

Everstone did acquire an $80 million fund raised from local LPs in 2005, the first fund in its platform, but that was purely something it inherited from a local partner in India. "Since then we haven't raised any money locally, only from global LPs," clarifies Dhanpal Jhaveri, Everstone's CEO.

Of the global LPs, those most commonly targeted with success in today's climate are the endowments and sovereign wealth funds based in the US and Europe. US and Asian fund-of-funds located in Hong Kong and Singapore are also an increasingly popular source of capital. But unlike ChrysCapital and Everstone, not all GPs have been in luck in their attempts to tap investors overseas.

"People are having a really hard time raising money," says Utamsingh. "Several funds have been struggling for 18 months or even longer. If you look at the number of funds that are successful, it literally is a handful. It's not a question of 200 funds raising $300 million each - only seven or eight funds have raised that kind of money."

And if a lack of capital isn't bad enough, newly-created fund managers - such as Omnivore Capital, PTC India and MCap - have had to suffer the expense of traveling the globe in order to raise that all-important first vehicle.

Knock-on effects

To some extent then, the absence of local LPs appears to be working against the development of Indian private equity at the GP level, as HarbourVest Managing Director Sebastiaan van den Berg said at the AVCJ India Forum in Mumbai last December.

Nevertheless, industry participants appear divided as to the impact that greater participation from domestic LPs would have. "It won't change anything actually," says Gulpreet Kohli, managing director at ChrysCapital. He claims that even if Indian institutions could invest more substantially in the asset class, many firms would be reluctant to take their money due to the lack of conflict issues abroad and the more sophisticated nature of LPs overseas.

"Indian private equity has already grown without local capital," Kholi says. "One of the things that I've heard from everyone is that there's too much foreign capital coming in. It's changed a little bit because fundraising is becoming tougher, but it's not as if there's an issue for capital."

Even he concedes, however, that a more active local LP base would lead to a much higher proportion of Indian GPs fundraising on home territory. One reason this is easier than seeking funding abroad is the understanding that domestic LPs have vis-à-vis the Indian business dynamic.

They are inevitably going to be less concerned by governance standards at the portfolio companies they invest in, or legislation such as the Foreign Corrupt Practices Act, than a pension fund located on the other side of the world. PIPE deals, a common feature of Indian private equity, have also been notoriously difficult to sell as a strategy to LPs.

Another advantage that more local LPs could confer on GPs is the ability to invest larger quantities into sectors in India which are restricted in terms of the use of foreign capital. FDI regulations that restrict overseas investment into multi-brand retail, or certain parts of the financial services sector, for example, could be by-passed by funding from local institutions. Similarly, fund managers who specialize in sectors typically neglected by foreign investors - and the sectors themselves - could benefit enormously from local support.

"At the moment there's a part of the market where financing is not available, because foreign institutional investors don't understand it, such as agribusiness," says Anubha Shrivastava, managing director for Asia at CDC Group, the UK government's development finance arm. "Agriculture is a big part of India's GDP - agribusiness should therefore feature as a private equity theme one would think, but there's a lack of institutional interest from investors."

She adds that healthcare and education are also better understood by local LPs.

Foreign comfort

While having a domestic equity base is important to Indian GPs, it would mean even more to the international LP community, according to a survey conducted by Stanford University and KPMG India.

"It would be very desirable to have more local LPs," asserts Bruno Raschle, chairman and founder of Swiss fund-of-funds Adveq. "It would make a great contribution to more local governance if insurance companies, banks, and pension plans would also get exposed. Why should the international community move into India when you have no locals investing?"

Foreign LPs such as Adveq are also likely to feel more comfortable knowing there's another set of investors on the ground in India to take care of their interests. Being far removed from the country makes it challenging for many to understand certain situations, and domestic investors are seen to be more knowledgeable about local business practices and risks. "It'll be easier for us to mobilize capital; we won't have to explain the strategy," adds CDC's Shrivastava.

With the advantages conferred by a greater prevalence of domestic LPs all too apparent, all that remains is for the Indian government to act. The Chinese government's realization that private equity could help drive growth led to the creation of renminbi vehicles, which now dominate the local fundraising scene. Surely we can expect something similar in India?

"Never, absolutely not," says KPMG's Utamsingh. "Don't forget the government of India has survived through populist measures. They don't survive on measures which are not meant for the common man - so this will never be on the government agenda."

If the government were to change its mind, it's likely that Indian GPs would seek to implement a similar structure to their Chinese counterparts - having two different pockets which get raised by the same manager. But Everstone's Jhaveri and ChrysCapital's Kohli both pour water on this idea. "They will not touch this," maintains Kohli. "You'd need a Parliament Act first of all, and that's not happening in a hurry."

Family support

If Indian institutions remain effectively straitjacketed for the foreseeable future, the emergence of high net worth individuals (HNWIs) - acting directly or through family offices - could provide hope for local GPs. Local family offices are gradually starting to invest in private equity, particularly those which have sold off former assets.

The Piramal group is a case in point. In 2010, Piramal sold off its India pharmaceutical business to US-based Abbott Laboratories for $3.72 billion. As well as setting up two of its own PE vehicles, a real estate fund and a healthcare fund, Ajay Piramal is expected to invest $5-10 million in several third-party funds.

According to the 2011 Capgemini-Merrill Lynch Asia Pacific Wealth Report, Indian HNWIs - defined as people with in excess of $1 million in investible assets - were worth $582 billion in 2010, nearly double the figure from two years ago. Alternatives accounted for 6% of assets, and it is generally accepted they will increase their contributions to private equity in the coming years.

However, at less than 1,000, the number of family offices still remains small and many fully intend to keep investing in their own businesses. These include the Singh brothers, who sold Ranbaxy to Daiichi Sankyo five years ago and have since reinvested the billions they made in building out a hospital business and a financial services business.

There are also risks associated with relying on capital from HNWIs, as during the downturn in the market over the last few years some defaulted on their investments, ostensibly due to a lack of understanding about the illiquidity of private equity. Shrivastava believes the solution to this is education: "If you take capital from the HNWIs and the small family offices now emerging in India, then they need to be educated about the asset class because it doesn't work like the public markets they're used to."

For the time being, then, family offices and HNWIs aren't set to become a dominant force in the LP community and the overwhelming consensus is that institutional investors will be barred from participating in a meaningful manner for the next 5-10 years at least.

Integrating more domestic LPs is clearly going to be an evolutionary process. As the asset class becomes a more significant part of the Indian investment landscape, and as regulations become more inclusive, we will inevitably see increasing activity from local LPs. Until that day comes, though, the simple truth is as Utamsingh says:

"Once the private equity industry really starts doing well, it'll be foreign investors who'll be making the returns and not domestic investors."

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• Topics
• LPs
• South Asia
• Fundraising
• India
• LPs
• Fundraising
• Multiples Alternative Asset Management
• ChrysCapital Management
• Everstone Capital
• KPMG
• Family office