Gatekeepers to Asian Private Equity (PEI Asia, September 2008)

8/18/2019 Gatekeepers to Asian Private Equity (PEI Asia, September 2008)

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F U N D S O F F U N D S

From a decade ago, when Asia had only a

couple of private equity fund of funds in

operation, the region has come a long way:

even by conservative estimates, at least 35

funds of funds managers are active in the

region today.

On the face of it, the proliferation would

seem easily explained. After all, Asia is

the fastest growing economic region in

the world; a large number of companies

are on the cusp of making the transitionfrom being small domestic heavyweights

to bigger regional, if not global players;

consumption expenditures are on the rise.

All of this has created immense potential

for private equity investments to generate

high returns.

In the circumstances, the increase

in the number of funds of funds is not

surprising. Many institutional investors

in Asia are for the first time exploring

private equity in search of returns that

could potentially outstrip returns gener-

ated from more traditional asset classes.

Insurance companies, financial groups

and national pension schemes are all

looking to diversify their portfolios which

until recently were made up mainly of

investments in bonds and listed equities.

Simultaneously, there is also an increasing

influx of capital from investors in other

parts of the world who are beginning to

buy into the Asian growth story and are

keen to become a part of it.

Chris Meads, a Hong Kong-based partner

at Pantheon Ventures, which is currently

committing capital out of its fifth Asia-

dedicated funds of funds, says: “When

our first Asian fund was raised, Asia was a

sideshow. Today investors regard Asia as a

core part of their investment portfolio. The

luxury of being able to ignore Asia is not

available anymore.”

As a result, a multitude of fund invest-

ment teams have launched Asia-focused

funds of funds in recent years. The capital

they have channeled into the region has

contributed to a significant increase in fund

formation activity.

In recent times, Asia has seen some very

large funds close. Fund sizes have multiplied

by a factor of three and sometimes even

four. And the number of GPs has been rising

rapidly as well. Market participants estimate

that there are at least 400 private equity

funds in the region today.

Research conducted by SCM Strategic

Capital Management, a Zurich-based invest-

ment group specialising in private equity,

real estate and infrastructure, which recently

opened an office in Hong Kong, shows that

more than $33 billion was raised for the

Asian market last year alone, a 30 percent

increase over 2006. In total, 149 private

equity funds were raised in Asia.

Markus Ableitinger, director and head

of investment management Asia at inter-national fund of funds manager Capital

Dynamics, says: “The Asian market is on the

global scene and private equity exposure

in Asia has become a really important part

of any global private equity portfolio. The

Asian economies are still largely under-

penetrated in terms of private equity as

compared with the US and Europe, so there

is scope for inherent growth. Finally, inef-

ficiencies in Asian companies are usually

greater, and that is attractive for private

equity investors.”

Capital Dynamics has invested more

than $730 million in Asia in the last three

years and has started marketing an Asia-

dedicated fund of funds, the group’s first

such product.

HUGE CHOICE

The sheer size and diversity of Asia’s private

equity markets is one of the main factors

that explain the prevalence of funds of funds

Gatekeepers to Asianprivate equityContinued keen interest in Asian private equity on the part of insti-tutional investors has kept fund of funds managers very busy. But aseconomic growth weakens and capital deployment slows, the futureholds some interesting challenges. Siddharth Poddar reports.

“There has been an evolution in

the manager universe, and the

range of investment opportunities

has also increased.”

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in the region. Says David Pierce, chief execu-

tive officer of Squadron Capital in Hong

Kong: “There are now many Asian funds of

funds, most created in the very recent past,

with or raising large sums. It is natural to

wonder: why so much money so rapidly?

We see considerable demand among inves-

tors globally, who feel it is time to invest

in Asia and that a fund of funds is the best

way to address markets where they lack the

experience, language skills and networks to

select managers.”

From emerging markets such as India

and China, to developed markets like

Australia, Singapore and Japan, to fron-

tier markets of the likes of Pakistan,

Cambodia and the Central Asian coun-

tries, the choices available to limited

partners are huge. Often, limited partners

just cannot cover this diverse range of

managers effectively.

Pierce says: “Our LPs are quite sophis-

ticated. They realise that they don’t havethe human resources in-house to cover

properly such a large and diverse part of

the world. This is true even of our Asian

LPs. Even LPs who normally go direct

find a fund of funds managed by a large

and experienced team to be the best way

to access Asian private equity.”

A recent survey conducted by Epiven,

a specialist private equity advisor on

China, revealed just how important

a role funds of funds are playing in

providing access to the country’s

private equity market. According to the

study, 66 percent of European funds

of funds are committed to Chinese

private equity, as compared to 33

percent of non-funds of funds limited

partners. (Interestingly, 28 percent of

European funds of funds even said that

they would be interested in investing

in China through other funds of funds.

Such a strategy may help plug gaps

in terms of market knowledge and

penetration, but it would also result in

higher fees.)

Dominic McGlinchey, a managing

partner at Epiven, says: “I think one

advantage of funds of funds to investors

is that [they] can help them resolve issues

regarding transparency. Of course, it is

important to work with a fund of funds

that specialises in Chinese private equity

and has a track record. Another route is to

invest directly by working with a specialist

that knows the market.”

H O M E G R O W N G R O U P S A N D

INNOVATORS

A direct result of the increasing popularity

of the asset class in Asia is the emergence

of local funds of funds managers investing

in the region.

Firms such as Asia Alternatives, which

has offices in Hong Kong, Beijing and

San Francisco, and Axiom Asia Private

Capital in Singapore have been active in

the region for a couple of years now. Eagle

Capital and IDFC Global Alternatives in

Singapore, and ICICI Bank in Mumbai, are

also raising funds of funds.

A key aspect drawing limited part-

ners towards investing in private equity

through local fund of funds is their

knowledge of fund managers in the

region. Fund of funds professionals

spend a lot of time on the ground and

get to know new GPs, giving them the

advantage of knowing their investment

teams, deal sourcing processes and

investment management capabilities.

For an institutional investor sitting in

another part of the world, this is much

harder to achieve. As such, finding an

experienced fund of funds manager that

specialises in the evaluation of Asian

GPs and the conduct of due di ligence on

their funds is an attractive proposition

for many.Homegrown funds of funds that focus

either on the region as a whole or on

certain pockets tend to develop a deep

understanding of the markets in the

region, and the prospects of private equity

within them. In conversations with fund

of funds managers, the importance of

networks, relationships and trust come to

the fore time and time again. Most impor-

tantly, there is a view that there is space

for homegrown fund of funds managers

to compete alongside the international

houses, primarily because the region offers

such a wide spectrum in terms of diversity

of markets and investment strategies.

As the private equity market in Asia

continues to develop, a number of funds

of funds concentrating on individual

countries, specifically China and India,

have also been created. Examples are

Evolvence India, which is based in Dubai,

and China-focused Jade Invest, which

has offices in Beijing and Shanghai.

Meads: Asia no longer a sideshow



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An untested proposition, the jury is still

out on whether single-country funds of

funds will be able to match the returnsof more conventional fund of funds

managers with a pan-regional focus over

sustained periods of time. The question

is whether individual markets in Asia are

deep enough to sustain country-focused

strategies, and it is no surprise that with

China and India, it is two very large and

rapidly growing economies that have

attracted single-country FoFs.

Another innovative strategy now being

put to the test is fund of funds offerings

targeting Asia’s growing private equity

real estate segment. Composition Capital

Partners, headquartered in Amsterdam, is

among the first real estate funds of funds

to set up shop in the region with an office

in Hong Kong. William Shaw, director

for Asia at the firm, which launched its

first Asia-dedicated real estate funds of in

April 2005, says that there is a “very strong

growth” in the number of real estate funds

in the Asia Pacific region. Tapping this

growth, Composition Capital Asia Fund Iclosed in July 2006 on $175 million, and

was fully committed by November last

year. The firm is currently raising capitalfor a second Asia-focused product.

CONSEQUENCES OF THE DOWNTURN

Amid increasing competition for bothinvestor capital and access to Asia’s best

GPs, funds of funds are working hard to

position themselves for future growth.

Meads says: “Our Asian investment strategy

has definitely changed. From the time

we raised our first Asian vehicle in 1994,

we have seen the Asian financial crisis,

the opening up of markets such as South

Korea and the emergence of buyouts in

Asia. There has been an evolution in the

manager universe, and the range of invest-

ment opportunities has also increased.”

All funds of funds interviewed for this

article spoke about a change in investment

strategy, and the increased pace of invest-

ment in the region. They also referenced

the dramatic change in financial markets

sentiment that has occurred recently.

Up until last year, the stock market

boom in the region, especially in India

and China, provided exceptional returns

to growth capital funds and other types of

private equity investor who exited theirportfolio companies through IPOs. Now

however, stock markets have come down

sharply, and the IPO window has closed.

In additions, the Asian economies have

shown signs of a slowdown as well, and

leverage, although still available for most

transactions in Asia, has become more

expensive.

In short, life now seems a fair bit

tougher than it did a year ago. Asia’s fund

of funds professionals are obviously cogni-

sant of this change.

Meads says: “The 2003-2006 vintages for

Asia are among the best performing funds

of all time. I think it’s going to be more

challenging for the 2007 Asian vintage

funds. It is unlikely we will see IRRs as high

as what we saw between 2003 and 2006.”

“[The change] hasn’t affected us at all

really,” Ableitinger says. “The thing with

funds of funds is that from an investment

strategy point of view, timing the market

is difficult. In distressed times when


Pierce: how will managers deploy their funds?

Source: SCM Strategic Capital Management

ASIAN CAPITAL OVERHANG IN THE MAKING


Commitments Investments

$ m

2000 2001 2002 2003 2004 2005 200720060

5000

10000

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Erasmus Habermel, detail from “Perpetual Calendar”,c. 1600. ©Collections of the Prince of Liechtenstein, VaLiechtenstein Museum, Vienna

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economic parameters are down, funds of

these vintage years usually perform well.”

However, he adds: “In terms of the

transformation of businesses that fund

managers invest in, the current envi-

ronment is not good. And if economic

parameters continue this way for

another four to five years, then exit

conditions aren’t going to be great

either.” He says that recent funds that

raised a lot of money and have invested a

lot of it quickly will face challenges. But

he also notes that conditions in emerging

markets tend to change quite quickly, so

that an overly pessimistic forecast might

well be outdated before long.

One redeeming feature of Asian private

equity may be that the use of leverage

in regional transactions has not been

as aggressive as it has been in Western

markets. Pierce says that even where

leverage has been used in Asia, it wasn’t

the sort of leverage that was common in

the US and Europe prior to the credit

crunch. He insists: “The impact on transac-

tions to date has been relatively modest,

more psychological than actual.”

HOLDING BACK

Nevertheless, the pace of deal-making

has undoubtedly come off since last year.

As Meads points out, “I think we’re going

into a period of slower activity. 2007

was frenetic in terms of fundraising by

underlying Asian funds. This was because

managers were making quick deals and also

possibly because managers knew tougher

times lay ahead.”

The fact that plenty of capital raised

for Asian private equity remains to be

invested is also a concern. “How will

these managers deploy their funds?”, asks

Pierce. “Some have raised more money

than they initially sought and several

seem to have more than they have the

ability to sensibly deploy, which has led

to some unwise, over-priced deals.” He

adds that less experienced managers have

a tendency to invest very quickly, which

is always a concern for limited partners.

Even though new capital continues to

be raised, it seems inevitable that private

equity fund formation in Asia is going to

slow down in the coming months, enabling

a period of reflection and consolidation for

the industry. Funds of funds with money

to invest are likely to make new commit-

ments selectively. They will also keep a

close eye on their existing portfolios in

the hope that the underlying funds will

continue to deliver the returns that the

boom-times promised.n

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Gatekeepers to Asian Private Equity (PEI Asia, September 2008)

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