Why asset owners should adjust their thinking about PE

Asset owners are taking to private equity investing with a vengeance, but competition for investments in leading funds and in some cases difficulties in selling assets mean some need to adapt their approaches, say industry advisers and executives. 

That could include targeting investment areas they are not very familiar with and being prepared to lower their return expectations.

Part of that approach involves targeting new tech areas, according to Edwin Chan, regional head for Asia at Hong Kong-based placement agent Probitas Partners. He told AsianInvestor that regional asset owner limited partners (LPs) need to be more entrepreneurial and embrace technology opportunities in China and around Asia if they are to find new investment opportunities. 

“The most exciting sector right now, for example in China, is venture [capital] with investors going into the serious A and B rounds to find the next unicorn," he said.  

It’s an approach also supported by Timothy Tsui, director of the Hong Kong single family office Arbutus. He suggested that LPs seek out opportunities in fintech, medtech and education: “It’s a hedge, not a speculation – that’s how I see PE. You definitely have risk at an early stage, but with the right management and strategy, you can really do well.”

“Technology can potentially kill a family business in two to three years – so I want to put myself in a position where I can adopt new technologies.”

There’s certain room for exploration. According to Probitas research, China-focused funds are now the second largest venture capital market after the US. But Chan noted LPs looking to invest in private equity needed to find GPs they could be comfortable with. 

“The key for LPs is to find GPs that have the right institutional mindset. It’s all very well to say these things about entrepreneurs – that they are gung-ho, they are smart. But if they don’t have that institutional mentality, it may not be the right fit with an institutional investor’s portfolio,” he said.

LIFE EXTENSION

Asset owners weighing up whether to increase their private equity allocations also need to consider whether the returns they want will meet with reality. 

That’s becoming a more difficult assumption, as the industry in Asia Pacific increasingly sees lots of money chase too few deals. 

“When you see large deals in Asia Pac coming round, there’s kind of a feeding frenzy among the big buyout firms; it becomes very competitive,” noted Grant Morrison, head of private markets at Melbourne-based superannuation fund Cbus.

A dearth of large viable deals has resulted in buyout firms hunting for opportunities in the listed equity space. The Singapore Exchange has suffered probably more than other exchanges in Asia from privatisations, with billions of dollars of capital withdrawn in 2017 and 2018. That demand is also causing asset valuations to rise, which threatens to force returns down – another reason why Australia’s superannuation fund Cbus is winding down its global private equity portfolio.

The pressure of finding and investing money has also come at a time when reports have risen that some funds have had to extend their typically 10-year operational cycles by a year or more in order to sell down long-tail assets. 

“That’s a trend that we’ve seen because it drives secondary transactions, which have definitely picked up,” said Robert Woll, a partner who focuses on China-linked private equity legal work at Mayer Brown. “A lot of those funds invested in China, India and pan-Asian funds have been extending their lives by typically one to two years.”

Adding a year or two to the life of a fund can be painful for an asset owner because it means they get their money back later – and it can potentially mean the fund sees its overall internal rate of return drop too. 

“Extensions have been more common and that is leading to more GPs trying to leave secondary transactions to try to find other ways to get liquidity for their LPs,” said Woll. “And that‘s something asset owners are concerned about. When a portfolio is so illiquid for so long, and then they have to find a liquidity solution at the end of the fund’s life.”

However, not everybody believes fund extensions are a major problem. “In the market right now, people may be struggling to sell because the market is not where they want it to be, or they cannot find a strategic buyer,” said Chan at Probitas. “You may be hearing some horror stories but I wouldn’t say that’s indicative of the market.”

Yingyoung Nilasena, deputy secretary general for fund management at Thailand's Government Pension Fund, added that he hadn’t come across any cases where the GPs wanted to extend the life of their funds because they couldn’t sell at a satisfactory price: “There is a lot of demand, so the market is quite liquid at the moment.”

CORRELATION RISING

With fees and valuations both weighing on investors’ concerns about private equity investing, private equity is facing increased questions about whether it can sustain its edge compared to more liquid assets.

Chris Leahy, founder of Singapore-based risk advisory firm Blackpeak, believes private equity should do so, but notes there are risks too – one being the asset class sees increased correlation with public markets as private equity funds pursue more privatisations. 

“It’s less of the traditional method of investing in company for seven years, grow it and then list on the stock exchange," he told AsianInvestor. "Now it’s take a listed company and flip it onto another market. There’s more of an asset trading mentality, and it’s becoming a bit more correlated, so the added alpha might not be quite as pronounced.”

The reality for asset owners is that they may have little choice but to add private equity, even if it fails to offer the sort of diversification it once did. Many regional investors are seeing their asset bases continue to rise, courtesy of pension savings or more insurance premiums. Private equity offers a compelling way for them to put some of that money to work. 

It just might not be quite as compelling as it was a few years ago.

This article was adapted from a feature that originally appeared in the Summer 2019 edition of Asianinvestor magazine.