Regulatory tumult in China has not materially shaken LP faith in Asia Alternatives or the fund-of-fund manager’s commitment to China – but an increased India allocation is likely in the latest vintage
Asia Alternatives launched its sixth pan-regional fund-of-funds against a backdrop of geopolitical tensions and pandemic-related uncertainty, completed a first close in September 2020, and then was ambushed by China’s regulatory upheaval last year ahead of USD 2bn final close.
“All of them,” said Rebecca Xu, a co-founder and managing director at the firm, when asked which of these headwinds blew strongest during a longer than normal fundraise. “It’s hard to single out one because they are all somewhat related. And even though we have high conviction on China, we are still understanding the implications of these forces. We must look into and analyse everything.”
Asia Alternatives has deployed about half its capital in China historically, spurred by the economic impact of fast-evolving consumer demand and technological advancement. This is likely to remain the case for Fund VI. While most existing LPs are in alignment – over 85% of the corpus constituted re-ups – the firm found that investors generally are re-evaluating their positioning on Asia.
“Some LPs are taking a pause on deploying new capital in the region, but others are seizing on the market cycle opportunity and want to double down on China,” said Xu. “LPs have become so much more informed on Asia over the last 15 years. We had a lot of smart conversations about how to think about China in the near term, how to do deal with challenges, and how to think about it in the long term, and whether it’s still an attractive market on a risk-return basis.”
Participating LPs include some of the largest pension funds in the US, such as New York State Common Retirement Fund, Florida State Board of Administration, Minnesota State Board of Investment, and Virginia Retirement System. There are joined by an assortment of corporate pensions, endowments, foundations, insurers, and family offices from around the world.
Fund VI is similar in structures to its predecessors. There is a co-mingled fund-of-funds of USD 1.1bn and the balance is spread across a handful of separately managed accounts (SMAs). In Fund V, which closed in 2017, the co-mingled-SMA split was USD 1.52bn-USD 285m; in Fund IV, two years earlier, it was USD 1bn-USD 800m. One-third of Fund VI is earmarked for secondaries and co-investment.
Given the shifting macro conditions and investment climate, Asia Alternatives believes it must demonstrate more vigilance in manager selection than before, especially in China.
Portfolio GPs in the venture capital space had begun to gravitate towards enterprise services, deep-tech, and hard-tech prior to the regulatory onslaught in their traditional consumer-internet stamping ground. The motivating factors were economic. Now, though, everything must be viewed through a policy lens as well, with all managers favouring sectors that have clear government support.
Asia Alternatives divides its exposure into red, yellow, and green zones: red for no-go areas that are not in line with China’s broad common prosperity directives; green for segments that enjoy policy tailwinds, like new energy, carbon neutrality, and electric vehicles; and yellow for those that could go either way and must be addressed with care. Xu is confident in managers’ ability to do this.
“Our GPs have grown up with many regulatory storms. This time it seems to have been swift and forceful and caught some people by surprise, but when they come back and reset their investment lenses, they are able to assess opportunities clearly,” she said. “Chinese entrepreneurs and managers have always been resilient, nimble, and adaptable to overcome cyclical challenges.”
Beyond China, Japan and South Korea are expected to account for 20-30% of Fund VI, in line with the last two fund cycles. Asia Alternatives is a fan of the small to mid-market buyout space, characterised by succession situations, corporate carve-outs, limited competition for deals, and readily available leverage. It has also noted increased deal flow in the large-cap space.
Every major market in Asia posted record levels of private equity investment in 2021 as USD 342.9bn was deployed region-wide, USD 130bn more than the previous peak in 2017. India’s transformation has been especially marked, with more capital committed in 2020 and 2021 than in the previous four years combined. The Fund VI allocation has been set at 15-25%, up from 10-20%.
“We have seen an improvement in the general market environment in the last several years, what with digitisation and the rise of the organised economy. This accelerated after COVID-19,” said Xu. “The exit environment has also meaningfully improved, which has attracted more capital. We see more opportunities in venture and growth, and in some cases, buyouts at the large-end as well.”
Consolidation to come?
Even as private equity investment in Asia reached a new high and exits rebounded to post the second-largest total on record, fundraising has stuttered. The USD 112.5bn raised in 2021 was the lowest since 2014 and represented a fourth consecutive year of declines, according to AVCJ Research.
Some GPs in the Asia Alternatives universe have requested extensions to fundraising deadlines, largely because travel restrictions have prevented them from getting in front of LPs. Managers usually approach LPs and discuss the length of the extension and any revisions to targets prior to making a formal request. So far, LPs have largely been supportive of extensions, Xu noted.
Nevertheless, close attention is paid to the underlying quality of managers and whether they have prudent capital deployment plans, irrespective of the fact that the timing of fundraises has been disrupted. With many LPs wary of making new commitments in markets like China, the bifurcation already evident in the market could become more accentuated, leading to consolidation.
Xu is wary of reading longer-term trends from the dislocations of the past 24 months. “Whether deeper down, this affects portfolio construction or the ability of managers to raise funds, it’s a little too early to assess,” she said. “But it might not be a bad window, where only GPs with strong track records, organisations and investment judgment raise a lot of money and those that are weaker might not be able to raise funds. We’ve seen that in every market cycle.”
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