Q&A: Eaton Partners' Chris Lerner

Q: What changes are you seeing in terms of LP interest in Asia?

A: I think we are seeing a resurgence in LP interest in Asia. This is driven first and foremost by the positive outlook and expanding opportunity set in the region. Global investors that look ahead and across markets recognize that the growth prospects and economic transformation over the next decade will be greatest in Asia. It helps that this turning point is coinciding with a positive global macro environment. The pie is growing so allocations to any individual segment of the market are growing. In addition, it’s important to point out that fundraising in the US has outpaced Asia in the last few years: distributions have been strong and so investors are doubling down on their commitments to private equity. Meanwhile, Asian portfolios that were previously marked up on the books are now being realized. Distributions have started to come back at an increasing pace, and so relative net exposures to Asia have come down. As a result, most institutional investors are under-allocated to the region at a time when we would expect target allocations to be increasing.

Q: A lot of the capital is gravitating to the larger pan-regional managers. Is that trend here to stay?

A: The change will be gradual and only moderate in the next few years. The large brand-name funds and pan-Asian strategies will continue to represent anchor portfolio positions for Asian exposure. That said, I think there is an under-representation of funds properly sized for the middle market and that must change. In the last decade, it made sense for the market to be dominated by large funds focused on capacity expansion plays and growth or reform in consumption-oriented segments of traditional industries, and smaller, earlier-stage funds that built new businesses leveraging the mobile internet. With the pillars of the consumer and digital infrastructure now built, we should see a transformation of the middle market as new companies emerge in the consumer and business services sectors. That will be driven by increasing customer segmentation and the need for productivity improvements across the value chain. This middle-market gap is underserved by traditional financial services, so operationally-focused PE firms can meet the funding needs.

Q: What is the biggest challenge for a relatively unproven manager seeking to raise a mid-cap fund?

A: Patience. Building relationships with prospective investors is important because they need time to get comfortable with making a long-term commitment, but oftentimes we see overzealous marketing and managers consistently on the road. Nothing can replace performance. When managers are constantly pushing for new capital, the perception can be they are doing so at the expense of performance.

Q: Are mid-market GPs in Asia committing more resources to IR? Where could they still improve?

A: We are seeing a continual movement of talent in-house for fundraising across managers of all sizes. Typically, these professionals are charged with finding new LPs. My feeling is that in many cases they would be well-served to first focus internally. Areas for improvement include transparency, consistency of communications, and institutionalizing best practices across all facets of a firm’s operation. Investor relations and business development professionals often have experience working with managers across multiple geographies, so their skill sets are suited to such efforts.

Q: Have you seen any changes in how LPs assess Asian managers?

A: I don’t think the fundamentals have changed in terms of their due diligence and landscaping of the market. What they continue to look for in managers is a repeatable formula for success and that is well adapted to the backdrop of the local market. However, when assessing managers in Asia there appears to be a heavy reliance on informal networks and reference points that often results in a partial view of the market. Moreover, as with any people-based business, but particularly when working across time zones and cultural settings, the phenomenon of human cognitive bias and the interplay of personal relationships have a somewhat outsized impact on decision-making.

Q: How important has sector specialization become in the GP community?

A: You have an evolution of types of managers in Asia and an important step in that process is the emergence of groups with certain sector specialization. Much like other phenomena, there are ebbs and flows, and we have seen an over-proliferation of specialists in certain sectors. It is no longer enough just to have a sector focus as your differentiation. There must be value-add as well, and that hasn’t always been the case in Asia, and in China in particular. The middle market gap will create opportunities between industry lines, so where I think we are headed is the advent of more thematic-driven investors that can look at how businesses across different sectors are being transformed, particularly as growth moderates and competition between businesses increase.

Q: Would healthcare be considered an overpopulated sector?

A: Yes, to a large degree we have seen an over-proliferation of funds dedicated to investing in this sector. The market opportunity is vast, and the risk-return is different from what we are used to seeing in more mature markets but with so many specialists chasing deals, unless you are investing with a top quartile or decile manager, you need to question whether, over a three or four-year investment period, you want to continue to put money with one firm in one space when valuations are high and there is so much competition for the same universe of deals.

Q: What impact is the rise of Asian LPs having on fundraising in the region?

A: We’ve seen an increase in Asian-based institutional capital willing to make long-term commitments to private equity and the emergence of professionally run Asian family offices that are new to or coming back to private equity. It means talented investors can raise first-time funds more easily – they might prove themselves in a Fund I or II with a largely local or regional LP base and then diversify in Fund III. While the rise of Asian institutional capital has been good for the industry and the ecosystem, it by no means diminishes the importance and prestige of having diversified reputable investors from the US, Europe, the Middle East, and other geographies.

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• Topics
• Fundraising
• LPs
• GPs
• China
• Asia
• placement
• Eaton Partners