Private equity activity freeze thaws in Asia

At least a couple of findings are evident as regards the way LPs, international and regional, see Asia and its opportunities, and their allocation plans for the region. First, both are expanding. All expressed ‘cautious optimism.’ But most also noted changes, particularly in their relationships with their GPs, as a result of the marked shift in the balance of power between the two sides.

Pioneer private equity and venture investor Adams Street Partners notes that about 10% of its global allocations are now in Asia (as compared to 55-60% in the US and 30% or so in greater Europe). Moreover, this balance is growing greater on the offshore side every year.

That said, however, Aazar Zafar, principal at Alberta Investment Management Corp., says that, while there is no doubt of the compelling opportunities to be found in parts of Asia from a macro perspective, there are also limiters, such as the available number of quality managers with a proven ability to deliver alpha. As well, there is the issue of timing to be considered.

T. Bondurant French, CEO of Chicago-based Adams Street Partners, completely agrees:

“People don’t plot along an efficient frontier, because you can’t price a first time fund, a second time fund or even a 13th time fund; you have to go in at par,” he explains. “Securities, on the other hand, do price along an efficient frontier, because you can price them. In selecting managers, on the other hand, you get better returns by taking on less risk.”

Although another global pension fund heavy hitter, Canada Pension Plan Investment Board (CPP IB) is a relatively recent arrival in Asia, being in existence only since 1997, it is solidly bullish on the region, according to head of global private equity John Breen. Following its thorough study of emerging markets, which highlighted Asia’s attractions, CPP IB has made some $2 billion of commitments to 8 managers and 9 funds in China, Korea and Japan – with preparations to enter India well under way.

“Basically, as a global investment firm with a single focus of maximizing investment returns without undue risk, we wouldn’t be doing our jobs if we weren’t developing a presence in Asia,” he says.

Steve Byrom, global head of private equity for Australia’s Future Fund, more or less concurs:

“Of the $6-7 billion we’ve committed to private equity already, more than $100 million has been earmarked for Asia with another three quarters of a billion dollars in the pipeline for 2010.”

“We’re playing themes looking for pockets of growth overall. And Asia certainly comes very high on the list.”

Local views

PV Wang, who is based in Singapore as a partner with Adams Street, adds:

“In Asia, the mood is quite different from what you find in the US and Europe. It looks like the regional recovery has already happened, with sentiment much changed after April/May 2009. It’s yet to be seen how this will ultimately work out. But activity is certainly picking up.”

Lachmi-Niwas Sadani, a director with AXA Private Equity Asia Pte with $26 billion under management globally, is likewise an Asia booster. AXA is an investor across most sub-asset classes, including fund-of-funds, directs, mezzanine, and infrastructure – though not venture, being high-risk averse. Their focus, however, is on a few top-quartile fund managers, favoring a country-focused approach as opposed to pan-Asian funds. AXA has capital committed to India, Japan, Australia and most predominantly China, with additional investments in Southeast Asia.

“The dynamics of the business are improving considerably here,” Sadani told AVCJ. “But one thing that is holding us back is finding the right quality of talent to invest with.”

Tough times

Kian-Woon Yap, global head of private equity with ING Private Bank, has a somewhat different viewpoint, given his firm’s weighting toward the retail segment, specifically HNW individuals who have traditionally not been much of a source for private equity funding. Yap claims this is now in the process of slow change.

“The last 18 months have been very tough times for my clients. They lost a lot of money. So over the past year, we’ve looked very selectively, and only placed small investments into defensive and contrarian plays, like secondaries and distressed, such as distressed real estate. Right now, most of my clients prefer to keep their money in relatively short situations (at most three year-type funds). But we fully expect private equity to come back over the next six to nine months.”

Kelvin Chan, a senior VP with Partners Group, notes that his firm was a first mover in setting up dedicated funds-of-funds for private equity in Asia. Historically, they’ve focused on China and India. They were also involved in Korea and Australia earlier in the decade, but backed off when they perceived overheating in 2007. Presently, however, they see these to jurisdictions normalizing once again, meaning their interest has returned.

“Going forward, I think we’ll probably step up our focus on smaller markets and the small-to-medium-sized sectors, which have felt far less of the GFC negative fallout,” Chan concludes.

New beginnings

PV Wang acknowledges that activity basically seized up between Q4 2008 and mid-2009, both in fund formation and transactions. But he sees that as wrapping up.

“The first sign is transactions being done on the ground, and the 3Q09 numbers show a ramp-up in this regard in China and India. Typically, fundraising lags that,” he contends. “If you look at our deal log, you’d see that it was pretty dry on the primary side for the first two quarters of 2009, with funds either putting their fund raising on hold or funds that we expected to launch deciding to postpone. But I think, with the combination of the feelgood sentiment now evident, they have come back, as has genuine investor interest.

“As well, I think that LPs are once again beginning to look at Asia, and my view is that, while there is some re-balancing and some investors who are in liquidity difficulties, emerging markets, particularly in Asia, continue to be very much on the radar screen. That comes across quite clearly in terms of some of the funds that have been successfully raised. While it’s not dramatic, some are finally having a first or second close. And GPs are calling again, not just to chit-chat but with draft PPNs or draft presentations.”

Lachmi Sadani-Niwaz is singing a similar tune:

“It’s not a secret that, in our industry, timing is everything. Nobody knows that better than the GPs themselves; because it affects their investments, their exits and their fundraising. So a lot was put on hold over the last year or so, because the timing simply wasn’t right. They knew that going out to raise capital in such an environment would mean less favorable terms for them. But as optimism returns to the market – even if it is irrational in some situations – the GPs who will do well today are those with very established track records. Those first off the blocks are those we would have invested in in any case, because they know that even in this environment they can raise capital on reasonable terms.”

Short-term blues

It’s not all sunny days short-term, however. As Sadani sees it, first-time funds will likely remained mired for six to twelve months. In part that’s because there is still an ambiguity about the recovery seen so far. Public markets have come back in a big way. And that means there has been an easing of the denominator effect, which effectively paralyzes private equity allocations. But the real economy, in contrast, has yet to revive as might have been expected. On the other hand, public markets are precursors of what is to come, not what is behind us. Still, the money is not flowing freely from investor pockets. And most is going to the long-established teams with the blue chip track records.

And Kian-Woon Yap of ING Private Bank adds, “For us, with our complement of retail investors, we really have to come up with something more creative. Some of the funds I’m talking to are wanting us to customize funds for them, small funds that specifically list the investment criteria, and how the fund will be invested and divested. In other words, the black box approach is not all that attractive right now.”

Furthermore, all agree that as far as the ‘cautious optimism’ characterization goes, the emphasis is on the caution – meaning, among other things, that there is no rush to jump in.
 
Says Kelvin Chan:

“Obviously, access is no longer an issue. But the current focus is on secondaries or direct investments, with no fees or carry. Yes, market sentiment is improving. But this caught all of us by surprise. Sure, we expect that Asia will be the first to recover. But it’s still the worst crisis since the depression. And while this may be the best time to invest it’s still a matter of pacing. And while we don’t want to miss out, we’ll wait to see more fundamentals, more data confirming a recovery.”

Changing times – and relationships

What’s more, all are very clear that the shoe is now firmly on the other foot in terms of LP relationships with their GP counterparts. Certainly they feel no urgency about coming on for a first close. There will still be placement possibilities further down the line.

“I don’t see this as a big issue. These days most GPs are happy to have us regardless,” as one puts it. “In this market, even if you are small capital, you are big; you get more mileage from your GPs. By contrast, in the not-too-distant past, if you wanted to get in, there were always some funds that were oversubscribed, meaning you’d get cut back. That’s no longer true. In fact, I think that even if you halve your commitment amount, you’ll still get an advisory board seat. In the past you probably wouldn’t, even if you put in $50 million.”

There’s also the competition with other asset classes to consider, as Kian-Woon Yat points out:

“We see ourselves as a consolidated distributor. We look at all interesting strategies because we have to compete across all asset classes. For example, the last few months have been a fantastic killing time for high yield bonds; invested in these you were realizing somewhere around 17% IRR; it was a no-brainer. So, while we’ll continue to talk to interesting GPs, we’ll test their stories against other asset classes with our clients to gauge their appetites for private equity funds. In other words, no active allocations; but we’ll keep in touch.”

PV Wang shares his views:

“The fund proposition has to be something that adds to what we have. The balance of power between LPs and GPs has really changed. So whether we come in on the first close or the final close, we’re now asking more of our GPs; for example, time to evaluate and do proper due diligence is clearly extended. And we no longer believe the story that ‘we’ll be closing in the next two weeks.’ Anyone trying to pull that off today would be asking for trouble.”

Another significant change can be seen in dropping deal sizes, as Lachmi Sadani points out:

“Change has come to Asian private equity in various dimensions. The crisis has highlighted the risk of investing in buyouts, because on top of operational leverage you have financial leverage to contend with. And in a downward-moving cycle, you’re faced with a higher level of risk and low returns on such investments. So another dimension that has changed is investors having a lower propensity to invest in large buyouts, the latter being also impacted by the lack of debt capital available at this time. So instead there’s an increasing focus on medium-sized buyouts and maybe growth capital investments. Which means the size of deals has come down. Which also means that the GPs are not raising funds as big these days as they were probably hoping a year ago. And that has implications for what LPs are deploying; they’re now looking to cut down their commitment to those funds.”

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• Topics
• LPs
• Funds
• Performance
• Partners Group
• Adams Street Partners
• Kelvin Chan
• T. Bondurant French
• Piau Voon Wang
• AXA Private Equity Asia