LP interview: Hamilton Lane

The incremental, China-led slowdown in Asia's emerging markets economies has stimulated investor interest in distress and special situations - the funds best positioned to capital on dislocation and restructuring opportunities. Even the deal structures are suited to uncertainty, typically offering a combination of capital protection through yield and capital appreciation through an equity kicker.

It is in this context that fundraising by Asia special situation funds reached $3.1 billion last year, compared to $2.2 billion in 2013 and $1.8 billion in 2014. The market remains a relatively small one - a single manager, PAG, accounted for close to half of the 2015 total - but Mingchen Xia, a principal at Hamilton Lane, expects it to grow.

"We have received a lot of inquiries from clients about these strategies because economies in Asia are going through transitional periods and that will create opportunities," he says. "Although the private debt market in Asia is still small, some global investors are arriving and there will be more GPs in the region."

Although the private debt market in Asia is still small, some global investors are arriving and there will be more GPs in the region - Mingchen Xia

These new managers are likely to have similar origins to those already active in the market: the proprietary trading desks of investment banks, which were scaled back in the wake of the global financial crisis. Others will be of more local derivation as the current crop of pan-regional GPs is complemented by single country players. For example, firms may spin out from Chinese asset managers with ready-made networks of service providers in different cities who can help resolve distress situations. It is in keeping with a broader movement from offshore to onshore.

"A lot of managers don't have onshore execution capabilities so we will see more of them trying to build out their onshore lending businesses," Xia explains. "This approach makes sense but we need to wait and see what the outcome is. There to four years from now, we will have a much clearer picture on this market."

In the middle

Hamilton Lane serves as an advisor to institutional investors with $204 billion in assets and has a discretionary portfolio of more than $34 billion. The managed solutions usually involve customized separate accounts - industry participants say these usually start at $100 million - plus some comingled primary, secondary and co-investment fund offerings. The middle market is a natural area of focus, in part because some LPs cover larger funds directly and so don't include them in outsourced mandates.

The Asia allocation from the discretionary business is approximately 10% and China is the largest recipient of capital. Much as the interest in special situations reflects broader changes taking place in the country's economy, Hamilton Lane is looking for managers that can evolve to meet market needs.

"Two things are important right now," says Xia. "The first is domain expertise. In this slower growth environment, companies need help from outside investors, not just money. GPs need to be able to provide strategic value and that comes from domain expertise. The second is post-investment management or taking control of a company. When markets are more volatile, control gives you more flexibility on exit. As a minority growth investor, you don't have much influence."

These two elements come together in that a GP with domain expertise is more likely to have the confidence and ability to manage a company. This applies to a manager with a $2 billion China fund that might have up to 50 investment professionals split into teams responsible for different sectors, and also to array of sector specialists emerging in China. Technology, media and telecom has long been the preserve of the venture capital firms, but GPs are now emerging in healthcare as well.

The question for all of these players is to what extent their professed expertise translates into more effective deal sourcing and investment management. Xia warns that specialization doesn't arrive overnight. "If you've done multiple funds over the last 10 years then you sector expertise forms naturally," he says. "For example, if you've made some successful automotive investments then deal flow will come from this sector through referrals from entrepreneurs and from your network, and then you can accumulate more knowledge and expertise."

Beyond China

Of Asia's other emerging markets, Southeast Asia and India are not as far along the evolutionary curve, with generalist and opportunistic strategies still prevalent. Southeast Asia struggles due to a shallow pool of local GPs and limited capital markets. Xia does not see this changing unless the region can address its macroeconomic challenges.

"If countries can grow their manufacturing and consumer sectors and consumption-driven businesses then their economies will become more diversified," he says. "As a result, the capital markets will change, currencies will become more stable because they don't just rely on resources exports, and current accounts will improve."

India's macro position is more encouraging than it was several years ago and Hamilton Lane's GP wish list reads much like the China version: there is a desire for managers with the capabilities to pursue control deals and contribute on the operational side. The problem is that returns look good on paper but there haven't been enough realizations.

"India faces the same challenge on the capital markets side as Southeast Asia in that the market is very domestic and IPOs can be closed for long periods of time," Xia says.

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• Topics
• LPs
• Fundraising
• Greater China
• South Asia
• Southeast Asia
• LPs
• Fundraising
• China
• Hamilton Lane
• India
• Southeast Asia