Indian LPs: Commitment issues

India's regulators have not yet opened the door for domestic pension funds to invest in alternative assets, but they are open to the possibility. If all goes to plan, remarks made by chairman of the Pension Fund Regulatory and Development Authority (PFRDA) could come to be seen as a watershed for domestic private equity and venture capital.

Hemant Contractor, the PFRDA's chairman, was speaking at a meeting of the Associated Chambers of Commerce of India in April. He indicated that, in response to a review of the investment guidelines for the National Pension System (NPS), PE and VC would feature in the phased roll-out of new asset classes in which the fund would be allowed to participate.

The PFRDA is expected to publish an official response in the coming weeks. However, private equity is unlikely to see much short-term benefit. Contractor said that the PFRDA was looking at a 2-3 year timeframe before the NPS would be ready to commit to the asset class.

Furthermore, any ramp up in exposure would be slow and from a low base. With an estimated INR820 billion ($13 billion) in assets, the NPS is a program launched by the government in 2004 for all Indian citizens. It is therefore unsurprisingly conservative. Over half of the portfolio is in government securities, a third in corporate debt, and just 8.1% in public equities.

But the development is significant in the context of incremental changes introduced in recent years to make investors more comfortable with domestic PE. These include the alternative investment fund (AIF) regime intended to allow tighter regulatory oversight of the asset class.

"I think there is an increasing desire among India's institutional investors - including pension fund managers - to look closer at growth private equity and venture capital as an asset class," says Sandeep Aneja, founder and managing director of Kaizen Private Equity. "This is partly driven by regulatory reform, but also partly due to the fact they would like better quality returns."

Limited exposure

While Aneja is not alone in identifying this trend, attracting domestic LPs to the asset class has historically been difficult. Opening up India's untapped wealth to private equity could be a long process, and one that requires more than regulatory reform.

Indian LPs that are active in PE have traditionally put most of their capital to work domestically, and these investments account for a relatively small portion of capital raised in the country. According to AVCJ Research, of the 184 recorded commitments made by India LPs over the past 10 years, 170 have involved funds with a country-specific focus. The average disclosed investment is $33 million versus an average fund size of $166 million.

It is important to note that these data do not capture all activity - high-net worth individuals (HNWIs) and family offices, for example, are under no obligation to disclose their commitments.

The latter group account for one of two broad categories of Indian LP. The other is larger institutional investors, particularly financial institutions and insurance companies, and they are said to be in decline. "In the last 4-5 years, funding from banks has come down considerably," says Vishal Tulsyan, managing director and CEO of Motilal Oswal Private Equity. "Some money has been raised on the real estate side, but pure play private equity growth funds have not seen a significant amount of investment from these domestics LPs."

AVCJ Research's records - which predominantly focus on banks and other financial institutions - show that funds launched in 2009 received 28 commitments from Indian LPs worth a cumulative $5.8 billion (where disclosed ). This number has declined with every vintage year. Funds launched in 2013 have so far raised $2.5 billion compared to $170 million in 2012. Each vintage has received nine commitments.

Part of this is down to regulatory restrictions. In 2012, the Reserve Bank of India (RBI) implemented Basel III framework, which limits the amount of risk capital banks can put to work. Another reason has been that Indian fundraising in general has been difficult. A lot of money entered the asset class in between 2006 and 2008 and valuations rocketed. Many GPs have subsequently struggled to exit investments, making it difficult to raise further funds.

Conversely, some observe that as HNWIs and family offices have grown in number and in assets, so have their commitments to private equity. Again, investments made by this group are not comprehensively represented by industry data, so its behavior can be hard to gauge.

Motilal Oswal's Tulsyan notes that there is more activity in areas such as infrastructure and real estate. Motital Oswal has raised two rupee-denominated funds, reaching at INR5 billion close on India Real Estate Fund II in 2012, and understood to planning a third.

"Indian investors - in particular HNWIs and family offices - are not yet at the level where they can patiently wait out the typical 10-12 year term of a growth equity fund," says Tulsyan. "Meanwhile, real estate funds raised in the last decade have typically been shorter term funds of between four and seven years. Moreover, Indian investors feel more comfortable investing money against hard assets."

This does not mean growth equity vehicles have no appeal. Kaizen, for example, is targeting around $120 million for its second fund and is looking to raise 45% of the corpus from Indian investors. Aneja explains that his firm's sector-specific approach has helped attract domestic LPs. "I think education is a sector that is easy to understand, and it is a sector that appeals to people's conscience," says Aneja.

Going direct

While some family offices may be active as private equity investors, they often struggle to justify making commitments to blind pool funds. Deep Chatterjee - executive director with Rasiklal Maneklal Capital, the family investment office of India's UniDEL Group - explains that UniDEL has previously participated as an LP in PE real estate vehicles, but the funds performed poorly. As a result the group has decided to focus on direct investments, specifically in venture capital.

"Increasingly, there are a number HNWIs and large families that have been able to get access to individual transactions as they are often part of same kind networks as the fund," he says. "Therefore they have access to the same kind of deal flow and they have the freedom to invest on a case-by-case basis."

Another consideration is that, by participating in the asset class on a deal-by-deal basis, family offices do not face the same liquidity issues that come with a co-mingled fund. This returns to the issue of Indian investors' general comfort with a long-term asset class like private equity. It is not unique to family offices and HNWIs.

While Kaizen's Aneja expresses hope that about more institutional investors will engage in private equity, he tempers this optimism by pointing out that fund commitments from Indian LPs can be inversely correlated with the performance of public equities. With the market at record highs - the BSE Sensex Index, having previously crossed the 20,000-point threshold just twice, has been trading above 25,000 points since last June - even large players are unlikely commit in the near future.

"That is an indication of the relatively short-term thinking of large institutions such as pension funds and insurance companies. They weigh private equity performance against the public markets," says Aneja.

However, taking a longer-term view, many believe it is a matter of when not if Indian institutional investors feature more prominently in private equity. Numerous sources argue that investor confidence will grow as managers build up their track records. In the meantime, any efforts by regulators to unlock some of this capital are welcome.

"It is still early days and Indian pension funds will time to understand the space, and carve out a strategy," says Renuka Ramnath, founder of Multiples Alternative Asset Management. "But I hope they will emulate their western peers and Indian pension funds end up being a huge pool of capital to tap into."

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• Topics
• LPs
• South Asia
• Fundraising
• India
• LPs
• Fundraising
• Multiples Alternative Asset Management
• Kaizen
• Motilal Oswal Private Equity
• Family office