Q&A: Capital Dynamics' Kazushige Kobayashi & Tokio Marine's Soichi Sam Takata

Q: How has investor sentiment in Japan changed since the introduction of Prime Minister Shinzo Abe's economic reforms package?

KOBAYASHI: Investor sentiment has improved dramatically over the past year under Abenomics. Overall, positive returns in the year ended March 2014 created more capacity for taking risk. In addition, we are on track to meet the 2% inflation target and investors are now seriously considering reviewing their investment strategy in this - modestly - inflationary environment.

TAKATA: It has changed, but I believe it is not necessarily a function of Abenomics itself, but more a result of the fact that stock markets have risen and the yen has depreciated significantly since then, improving their existing investment positions, enabling them to take more investment risk going forward.

Q: How important is the third arrow of Abenomics - structural reform - to PE and has there been any progress?

KOBAYASHI: The third arrow takes a long time to be implemented and to be effective. The government has been very active since presenting the first plan in June 2013 and a couple of the initiatives, such as enhanced corporate governance and public pension fund reform, have a positive, although indirect, impact on private equity. Continued implementation is very important for the Japanese economy, including the private equity industry.

TAKATA: The third arrow is important to the extent that it may have a reasonable impact on global investor sentiment on the medium-term prospects for Japan. However, I do not believe that it necessarily has a direct impact on private equity deal flow or other facets of the private equity industry. There are parts of the structural reform plans that can have an immediate impact to certain industries, and investment in those areas may benefit. While there has been little progress on the third arrow, it takes time - but I believe there is a reasonable chance that it can happen.

Q: What is the health of the domestic private equity market? Are the middle market and lower middle market GPs seeing more deal flow?

KOBAYASHI: We saw fewer new deals last year due to an overly rapid increase in public equity prices, and because GPs are busy exiting deals. Since the beginning of this year, we've heard that deal flow is picking up. The majority of transactions are still in the mid- or lower mid-markets, but we are also seeing large deals, such as the divestment of Panasonic's healthcare business and Sony's PC business.

TAKATA: The large end of the market has become competitive, as is the case with other parts of Asia where global players come in and crowd the market whenever there are opportunities. The middle market has become slightly underdeveloped as - due to a macro environment that hasn't been conducive to raising risk capital in recent years - many smaller GPs were not able to move up into the space after existing mid-market players grew in size.

Q: A lot of hope is being pinned to Government Pension Investment Fund's (GPIF) expected move into PE. Will it open up the asset class?

KOBAYASHI: We expect other public pension funds will follow GPIF once it starts to invest in private equity. Those public pension funds manage total assets of approximately $1.6 trillion so it will have a big impact. As for corporate pension funds, their structure and status are different from public pension funds and they do not necessarily follow the trend. But we think the public funds' move will create an impetus for corporate pension funds to revisit their strategy on private equity as well.

TAKATA: There is a reasonable chance that GPIF's foray into private equity will help to nudge other pension funds to invest in the asset class, but I believe the process will be much slower than one would expect, and the likelihood of the market expanding quickly is quite small.

Q: What is domestic LP sentiment like in general? Are they looking for more international exposure, secondaries and co-investment?

KOBAYASHI: Over the past fiscal year, insurance companies became active again and even commercial banks are now investing, although they need to be careful about regulatory issues and synergies with their business. Both of those invest internationally and they invest in secondary funds or buy secondary positions directly. As for co-investment, since Japanese LPs have limited human resources and are far from the US and Europe, they face challenges in executing such transactions by themselves.

TAKATA: Domestic LP sentiment has improved quite a bit in the past few years due to the rise in the public stock markets and the depreciation of the yen. Robust distributions in more mature private equity portfolios also help to reduce exposure, helping to increase appetite to reinvest money into the asset class. Given that the more mature markets are in the US and Western Europe, and given the likelihood of the yen depreciating further over the medium term is reasonably high, I believe many domestic LPs are comfortable expanding their exposure outside of Japan.

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