Japan fundraising: Talk isn’t cheap

Japanese GPs are grappling with a perception problem. It is generally accepted that the bumper funds raised in the previous cycle, prior to the global financial crisis, have failed to meet expectations. As a result, investors are voting with their feet and many domestic LPs are reducing their exposure or withdrawing from the asset class.

For mid-market private equity firms looking to replace exiting Japanese LPs with offshore capital, communicating their investment story - i.e. that they shouldn't be bundled in with bigger players - has become a make-or-break issue.
"The primary challenge we are facing is the deep perception gap between the international view of Japan and the reality," says Naoto Mizoguchi, managing director at GPDRC Capital, speaking at the AVCJ Japan Forum in Tokyo.

Certainly, less capital is flowing into Japan-focused funds. In the first half of 2012, a total of nine vehicle attracted about $253 million in capital, data from AVCJ Research shows. In the three years following the global financial crisis, annual average fundraising surpassed $2 billion; for 2006-2008, it averaged $6.6 billion.

DRC reached a final close on its most recent fund in April 2012 at JPY6.6 billion ($82 million). The entire process took two-and-a-half years. Domestic investors were first approached in 2009 and a parallel structure for international LPs was set up in 2011. This was the first time DRC had accommodated foreign investors, and it held road shows in Hong Kong, Singapore and the US in order to drum up appeal.

Other mid-market GPs are making similar efforts, undertaking frequent trips to Hong Kong to meet potential investors. Gregory Hara, director and president of J-Star, which is targeting around JPY15 billion for its second fund, told AVCJ last month that he has been communicating with foreign LPs for several years with a view to building direct relationships.

Know your markets

Turning around the situation requires effort on the LP side as well. Resources must be deployed to fully understand what the Japanese market has to offer: governance and cultural issues that feed into the Western-style private equity models aren't necessarily applicable in Japan. According to Greg Bayles, senior portfolio manager - private capital at Australia's Commonwealth Superannuation Corporation, achieving this level of comfort involved 5-6 years of dedicated effort using people on the ground.

A failure to understand the Japan market is one of several reasons for the perception gap, adds Saki Georgiadis, head of Asia at Hermes GPE, a UK-based private pension fund. Western investors have been trimming their Japan exposure for macro reasons: the country's economy has been treading water for a decade, while LPs have become accustomed to 2-3% GDP growth from the developed markets in which they deploy capital.

Attitudes might change now that Europe, for example, has run into economic difficulties of its own, but Georgiadis notes that there isn't always a correlation between GDP growth and private equity returns. "We've been investing in the Italian market for a long time and the economy hasn't moved in the last 10 years," he says. "It has lost about 30% of its competitiveness since joining the euro, but we've made good returns."

The most important issue, however, is fund size. Negative sentiment tied to the bubble in the last cycle means that GPs must convince prospective investors that their target fund size is commensurate to the opportunities available.

Asked what they look for in a manager, LPs participating in the forum panel express a preference for smaller vehicles. Bayles says it is Commonwealth Super's policy to move down into the mid-market when targeting country funds, because there are more ways to add value as opposed to relying on leverage multiples. Motoya Kitamura, senior vice president at Macquarie Funds Group, adds that he is biased towards smaller funds because he doesn't want to bet on the growth of the larger buyout market in Japan.

Georgiadis is the exception, saying that Hermes is agnostic towards fund size, but close attention is paid to average equity check size and the kinds of deals a GP wants to do.

Stretched too far

Even if the fund size is appropriate and the manager succeeds in explaining that Japan's mid-market differs from the larger buyout space, two challenges remain. Firstly, although the corpus fits the market, is it large enough to make the partnership sustainable and able to retain staff at all levels? Secondly, do smaller GPs have the internal skills and resources to raise money from a reconstituted LP base?

"Smaller GPs are less sophisticated in terms of the GP-LP relationship because they haven't got as much experience or they haven't been to Harvard," says Commonwealth Super's Bayles. "We have to ask how much money can the GP raise?"

For a GP that operates with limited resources and that can't support a large investor relations team, it is standard practice for investment professionals to spend months on the road fundraising. At the same time, they might be coordinating exit strategies for portfolio companies in order to prove to prospective LPs that they have ability to return money to investors.

The process is made even more difficult if intermediaries are unwilling to help out. According to John Fadely, a Hong Kong-based partner with Weil's global fund formation group, placement agents tend to focus on funds raising $250 million or more.

As to how all this feeds through to the wider perception issue, Fadely offers a neat contrast with China up until about 12 months ago. Such was the level of investor enthusiasm there that large commitments were made to domestic vehicles with little thought as to the country's economic trajectory. As a result, a lot of money has entered funds and there is little detail on how returns are being pursued and over what timeline.

Japan doesn't have the same problems, Fadely explains. "It's more a case of how do you make private equity work in a stakeholder culture. GPs must come out and tell the story."

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• Topics
• North Asia
• Fundraising
• Japan
• Fundraising
• J-Star
• Macquarie Funds Group