Something special

The principal defense of sector agnosticism is that deal flow in emerging markets is unpredictable and sticking to specific areas could mean opportunities foregone. A GP's deal log for just one week might include an oil-drilling tubes manufacturer, an air conditioning retailer, a copper miner, and everything in between.

And if a GP is relying on the public markets as an exit channel and a multiples arbitrage for profits, do sectors really matter? Investments are typically for minority stakes so portfolio company strategy changes only on the founder and majority shareholder's say-so.

Needless to say, conditions started to change in 2011 as public market exit multiples plummeted and then IPO markets ground to a virtual standstill.

The problems are not isolated to China - they are just most accentuated in this market because of the amount of capital raised on the premise of lucrative IPO returns. Growth investments across the region have been stymied by a reduction in exit options. On the buyout side, too, weaker leveraged lending markets have reduced the level of financial alchemy that can be used to juice up deals.

Nowadays, everyone is looking to highlight their operational expertise.
In certain respects, this is nothing new. AVCJ has covered the impact of a slacker IPO market on China growth investors before; a clutch of pan-regional players already pursue sector-specific strategies; and the global buyout firms have been hiring operations executives and even setting up units dedicated to operational improvement for several years.

The more contemporary evolution is threefold. First, the lag between China GPs discovering their world has changed and actually doing something about it has traversed its loop - anecdotal evidence suggests that a growing number of firms are pitching themselves as specialists.

Second, the nature of investment opportunities in emerging Asia is evolving - buyouts are gradually becoming more available, which means PE firms can actually bring the full weight of their operational expertise to bear.

Silver Lake and First Reserve, technology and energy specialists respectively, are instructive in this regard. Neither sector has delivered significant deal flow in Asia toward the larger end of the scale. And each firm has only completed a handful of transactions in the region.

But why be hasty? Sector specialists rely on the strength of their industry networks, often working with the same management teams or partnering with a handful of carefully selected corporates on multiple deals. Emerging Asia's globally competitive management teams and globally minded corporates are still, well, emerging.

Third, and perhaps most importantly, in a difficult fundraising environment, GPs must differentiate to survive. A plain vanilla strategy might work for a global buyout firm raising an Asia buyout fund; it can claim to have operational resources, international networks and financial muscle to add value to whatever companies fall under its control. For the small- to mid-cap players, though, it is a harder sell.

What can a GP say to convince prospective investors that it has the ability to outperform its peers? And what kind of LPs is it trying to convince? As investment strategies become more targeted, the target audience must also be honed. An endowment with a strong background in global technology is going to have different priorities to a fund-of-funds seeking exposure to a particular geography. In the case of some public entities, LPs are mandated to allocate a portion of capital to certain sectors.

It will take time for strategies to evolve on both the GP and LP sides, but even those that previously hid behind the veil of specialization will eventually get found out. A fund that boasts a specific focus on consumer, financial services and telecom, media and technology, for example, might justifiably be accused of awarding itself a mandate to do just about anything.

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• Topics
• GPs
• Greater China
• Exits
• Fundraising
• China
• Exit
• GPs