Fundraising perspectives: Capital providers on private equity

THE DEVELOPMENT FINANCE INSTITUTION

Bill Pearce, Acting Head of Investment Funds, Overseas Private Investment Corporation (OPIC)

OPIC is the US Government's development finance institution (DFI), focusing on emerging markets globally. It provides loans and political risk insurance as well as financial backing for PE funds

OPIC has both developmental and financial return targets so we keep that in mind as we put funding towards mid to smaller cap fund managers because that is where DFI capital is needed most. The private equity market has evolved to a point where we are seeing more indigenous funds being in the region, with new fund managers who are knowledgeable about the asset class. We view this as a positive trend.

In terms of our commitments, we would like to do more in Southeast Asia, not only as a foreign policy consideration but because it complements our focus on funds with growth market expansion strategies. We are trying to do more to round out our portfolio in that area as much as possible.

Across the board we are seeing pressure on management fees by LPs but I think there is a different dynamic in emerging markets - particularly with smaller, mid-sized funds because those fees are essential. Like many of our DFI peers, we look at the budget of the fund manager and see what kinds of fees they need to support the operation of the fund. Particularly with managers with offices in several different countries - which you need in emerging markets - we consider how managers justify the fees and will look to see that they follow best practices.

We are seeing more creative aspects on how fees are being managed, between the commitment period and post-commitment period, but I don't think you are seeing the dynamism in fees as you would see in the developed world. The fee structure in emerging market funds may be different than what you might experience with developed market buyout funds.

As a DFI, our mission is to catalyze more private capital investment into a given market. We will back follow-on funds on a case-by-case basis where DFI money still has an impact, particularly in OPIC's priority regions. I think DFIs will continue to have a catalytic role in the region and there will continue to be a movement of DFI funding to the frontier markets with next wave of funds.

Hopefully this will give many private sector LPs the confidence to invest in these jurisdictions as they appreciate the value DFIs bring in terms of expertise and contacts, and that is where we will continue to play a role in the future.

THE INSTITUTIONAL PLAYER

Phillip Bower, head of private capital, IFM Investors

IFM Investors is a global fund manager owned by 30 major Australian not-for-profit pension funds

Our clients have less of an interest in fund-of-funds as a product concept. They are seeking more direct mandates to go into funds, which is no different from other programs globally.

Fees are a major issue in the Australian superannuation sector. Some of the industry super funds are moving their investing activities in-house as a way of reducing fees. The overriding concern is that the sector has grown but the benefits from economies of scale have not.

As funds under management in the superannuation sector have now grown to A$1.6 trillion, you would have expected the management expense ratio (MER) of superannuation funds to have come down significantly. I don't think it has come down at a rate most super funds have thought appropriate and so they are putting pressure across all asset classes to reduce fees. In the case of private equity, the fees are the highest out of any of the asset classes so there is even more pressure.

I don't think the mergers of super funds will have any more, or less, specific impact on private equity because it is a specialist asset class. It is unlikely that super funds will move into direct activity with private equity in the near term; rather, they will continue to use fund managers or GPs to manage their business and we as IFM Investors are helping to perform that function.

The industry super funds sector in Australia comprises 6-8 funds that are really big and then it drops down quite significantly. So for super funds to get into direct investments, they need to have a large critical mass and I don't see them wanting to participate. In other asset classes such as equities and infrastructure, we'll see more direct activity.

The other trend is super funds looking at GP performance using global benchmarks. So whereas in their listed equities businesses they may say they need to have a certain proportion international and a certain proportion domestic, in private equity it's seen as a more homogenous market and they look at performance of GPs on a global scale.

When we talk to our clients, they talk about limiting the number of GPs they invest in. They used to spread money broadly across a large number of managers and what generally is occurring now is a comeback to a smaller set of GPs. They'll compare somebody in Sydney or Melbourne with somebody in Paris or New York, line the results up and say these are the guys who are performing and this is where we'll put the money.

THE EUROPEAN FAMILY OFFICE

Fritz Becker, CEO and Managing Director, Harald Quandt Holding

A Germany-based family office, Harald Quandt Holdings is also majority owner of global alternatives investment advisor Auda International

We have nearly 200 GP relationships globally and 29 in Asia, where we have been investing for more than 10 years. Including third-party money, we have around $5 billion deployed globally. Our net asset value is 12% Asia and on a commitment basis it's around 20%.

Asia hasn't underperformed but we expected it to outperform. When we started out we expected 2-3% more alpha than Europe and the US, but this has turned out not to be the case. We are not dissatisfied, but we have learned that, with the stock markets in China closed, cash flow patterns are behind expectations and the market is less liquid than anticipated. However, from a portfolio construction perspective we need and want Asia. It is an attractive market but it's all about finding the right GPs.

A lot of LPs go for large brand name GPs because it is easier to justify to their supervisory boards. In Asia we started with large GPs but over the years we have increased our due diligence capacity - our subsidiary opened in Hong Kong in 2007 and we have five people based there - and allocated more to mid-size and smaller GPs.

Do large GPs really generate better returns? Some yes, but most no. We do think there is a misalignment of interest in that these GPs are more management-fee driven than carry driven. Some of the big institutional investors want returns of 10-12% - their requirements for the entire investment portfolio might be 6-8%, or 4-5% in the case of a German insurance company - but I expect more from my niche GPs.

We are now looking for specialized funds, by segment or region, and you have some of that with infrastructure in India and consumer in China. There are so many more GPs out there today - more than 100 in Southeast Asia and 600-700 in China, not including the renminbi-denominated funds.

People are, from a European perspective, less loyal - if they are not satisfied with the existing team they spin-out and create a new one. We see opportunities here; we have already done it with twice in India and 3-4 times in China. The first fund is $200-300 million and they are happy to get a check of $10-15 million; they aren't asking for $50-100 million. We like to find these teams because they have a track record, they are looking for investors, and they tend to be much more incentive-driven and aligned with LPs.

THE ASIAN FUND-OF-FUNDS

Doug Coulter, head of Asia private equity, LGT Capital Partners

LGT Capital Partners is an alternative investment manager, based in Switzerland, with Asian affiliate offices in Hong Kong, Tokyo and Beijing

In terms of geographies, it's the US, Europe and Asia, in that order. There has been a slow increase in our allocation to Asia relative to the US and Europe. Asia is about 15% right now, moving towards 20% over the next 3 to 5 years.

In general, we prefer small to mid-market funds - under $1 billion. There are a few exceptionally good large funds that invest in Asia and we don't say it has to be small in order be beautiful. Sometimes these bigger funds bring a more international dimension and greater resources that can be useful in emerging markets. Size is important but it doesn't drive our decision making process at all.

The most interesting opportunities are in emerging Asia where there is growth. You have blind pool risk so the fact you have solid growth and low debt levels means the risk you are taking on is much lower than many people believe. The main risk remains the quality, strength and stability of the teams. Slower growth economies like Japan and Australia can be interesting on an asset-specific basis, so we look at them for co-investment and secondary opportunities.

China is the market most LPs remain interested in despite recent concerns, and more than half of our capital invested in Asia goes there. We are positive on the country's long-term development.

We think LPs are far too negative on India. If you loved India in 2007 when everyone was shoveling money in then you should like it today at a lower valuation. Starting with the currency, you are coming in at a much lower level. Then there is far less competition as many first-time and second-time fund managers are going out of business. It has never been an easy place to invest and make money but we think it makes sense having money there for the next cycle.

Some Asian GPs are able to close quickly, usually because there is something special about their story and they have delivered very good returns in the past. We are seeing more co-investment opportunities, in part because funds raised in this cycle have tended to be smaller or the same size as funds raised in the previous cycle, yet economies have grown so deal sizes are up on average. You do have a dynamic where funds are not bigger but deals are bigger and GPs prefer bringing in some of their LPs rather than other PE funds.

THE GLOBAL ANGEL INVESTOR

Dave McClure, Founder, 500 Startups

Dave McClure is a Silicon Valley-based super angel and founder of seed fund and incubator program 500 Startups. The group backs start-ups globally and also makes LPs investments in other seed funds

I think the angel investor's role in venture capital is becoming more structured. This means you are seeing more seed funds fulfilling the role which previously, and haphazardly, was fulfilled by individual angels. We have been an investor in a number of funds and this has mostly been for relationship purposes. For us, it has been about trying to establish different relationships around the world by having various regional partners. It has been useful for us.

In terms of investment opportunities, it varies country by country. China is becoming a more developed market; historically it has been a little bit overheated but that is starting to calm down now. In other markets, the environment is a little more constrained, though we are starting to see more activity now in Southeast Asia. Much of the rest of the region is underdeveloped. You have some pretty great opportunities at a low cost, but there is still significant risk.

The lack of downstream investor capital makes me nervous sometimes, but we try to work with local partner angels and funds to help companies get off the ground. I am pretty long-term bullish on the whole region and as the next 5-10 years play out we will see a lot more activity. I think there are some tremendous opportunities and we are going to see some great businesses being built.

One thing with investing internationally is that it can be challenging getting companies to the next level of seed funding. My preference is to see more seed funds develop and I think we are beginning to see the emergence of new breed of seed fund managers doing sub $100 million funds. It will take time for them to establish brand reputations in the same way as the more traditional funds, but you are seeing more thoughtful innovation and a different approach with regards to investing.

I think we are seeing more consolidation on the low and high end of the market. At one end you see large funds coming together. At the other end people are practicing more efficient models, scaled back to around $25 million per partner with a lot more of the funds driven by those with operating backgrounds and less by those with fund manager backgrounds.

THE ASIAN FAMILY OFFICE

Steve J. Kim, chief investment officer, Castling Investment Group

Castling Investment Group is an alternatives investment advisory firm based in South Korea

Korean investors right now are willing to sacrifice some of the additional returns or alpha for interim cash flows or liquidity. They don't like blind pool risk or the j-curve, so we're seeing secondary funds, credit funds, distress. It's less traditional PE that's catching a big wave of attention here today. However, things should normalize over time and you'll see more traditional institutional portfolios taking shape over the next decade.

Korean investments have traditionally dominated so a lot of the institutional portfolios here were invested mostly in domestic stocks and real estate. There's been a huge push to start putting capital to work in international markets. There were restrictions on institutions investing abroad so a lot of capital was trapped here for a long time, but now policies are easing up. This, coupled with the fact that Koreans were very slow to get into PE, means they are trying to catch up. There's a big push into foreign alternative investments.

The natural tendency for Koreans is to step out of their comfort zone in a very risk-averse way. They're looking at the international markets and thinking "let's start with the US and Europe." Generally speaking, they prefer Western investments to Asian.

Within Asia today there is more receptiveness to deals in China and Japan, as opposed to Southeast Asia. I feel there's been a lot of opportunistic capital raised out of Southeast Asia and while there is a growth story there, it's still a bit foreign and feels like a flavor-of-the-month play, so people have been shying away from the region.

In Korea there are basically three factors that drive fund investments - brand name, flavor of the month and the domestic factor. If GPs have one of these three, they're likely to raise capital. What's compounding this is the copycat effect - if one institution sees another doing it, it sort of de-risks any back-end mistake because they can always point the finger at everyone else who did it too. So a lot of people will commit to a GP because the National Pension Service has committed, for example.

There's a lot of pressure to move fees downward. It's case-by-case, but if you go to the largest institutional investors here with an early fund and are relatively unproven, you're going to get burned on the fees. You're going to be accepting fees that are just way below market. Established players with very large funds obviously have more leverage.

THE PRIVATE BANK

Roger Bacon, Head of Managed Investments, Asia, Citi Private Bank

Citi Private Bank develops and coordinates wealth management strategies for high net worth individuals

Prior to 2007, the vast majority of illiquid private bank clients' money would go into large global funds with a co-mingled blind pool structure. Over the ensuing 5-6 years there has been a dramatic shift in the way clients allocate. Most visibly, and this is true in Asia in particular, appetite for illiquids isn't as low as you might expect. There is a lot of cash sitting on the table and clients are prepared to deploy relatively large sizes into illiquid assets quite quickly. The new need is for transparency.

The demand side is different in other parts of the world. In the US and Europe it is becoming more difficult to raise money in illiquid structures, whether co-investments or blind pools because there isn't as much money available as there used to be. In Asia it isn't necessarily the case because people heading into the crisis were less levered.

We have spent the last three years focusing on two areas as part of this transition to a more transparent environment - club structures and single-asset co-investment.

The club structure is still part of a fund but it just happens to be a series of single-asset co-investments. What we've found is that, if a client was willing to put 100% of illiquid dollars into a blind pool fund pre 2007, they are still prepared to put some money into this area but there are two criteria. First, it must be a best of breed name. Second, they must have a clear view that independent due diligence has been done on the specific opportunity or specific manager before they pull the trigger.

We have a dedicated research team for private equity and real estate globally. We have people on the ground in all the main investment centers and their job is sourcing deals. We are also looking at specific themes where we don't have something on our platform that specifically exploits it. So our research team will approach managers and sponsors that we believe have some degree of differentiated expertise and see if we can structure something with them.

On the private equity and real estate side we don't do much fund-of-fund business - we are very much focused on the single deals. We have not seen significant levels of demand from clients for fund-of-fund structures, and we haven't seen truly differentiated offerings emerging that warrant our attention. There are too many parties involved and the net outcome for clients is relatively unexciting for the liquidity on offer.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• People
• LPs
• Fundraising
• LPs
• Asia
• Fundraising