Limited partners, battered by the credit crunch, are not intoxicated with Asia right now. However, for reasons including their historical over-allocation to developed economies, the comparative stability of developing Asian economies compared to the fragility of developed ones in the West and the returns that are still available in countries like China and India, is driving LPs to allocate more capital eastwards.
Even though all fund-raisings are currently frozen as a result of the financial crisis, Asia-focused private equity funds did raise more money than their European counterparts for in the third quarter, and the trend looks likely to be continued. In the period July to September 2008, Asia-focused funds raised a total of $12.5bn, more than the $11.9bn raised by European-focused funds for the first time in history, according Private Equity Intelligence.
“One of the main reasons that people have become more interested in Asia in the past few years,” says Christophe Florin, managing director of Axa Private Equity in Singapore, “is that they wanted to correct anomalies in their geographical allocations. Currently, they have most of their allocation in Europe and America.”
Coupled with the scope for better returns through the region’s maturing GP base, investing more money in Asia is a ‘no-brainer’ for many LPs.
Markus Ableitinger, head of Asian investment management at Zug, Switzerland-based Capital Dynamics, adds: “Asian private equity is developing rapidly and maturing, though it’s still at an early stage of its development. Asian GPs are becoming more experienced and LPs are starting to understand the return potential of Asian private equity, which can exceed that of the US and EU.”
“LPs are becoming keener on Asian exposure in order to balance their exposure to the US and EU,” adds Ableitinger. “Even though there is no decoupling between Asia and rest of world, Asia contains regions which offer above-average return potential and has markets like China, which appear more resistant to recession. The best GPs are emerging now, so gaining access to them is crucial.”
Philip Bilden, managing director of HarbourVest in Hong Kong, points out that increased allocations to Asia remain a relatively recent phonemenon. “In the last couple of years, overall LP interest in Asia has increased from a very low base,” he says. “Part of that can be attributed to a more normalized allocation to Asia.”
As the developed world plunges into a recession of uncertain duration, China and India remain beacons of economic light, at least for the time being. In the third quarter of 2008, China’s economic growth slowed to 9% and industry practitioners are confident that growth in the Asia’s two economic powerhouses will halve to 5% per annum in 2009.
There is also a ‘political backstop’ to continued economic growth in China. Some commentators believe that the Communist Party will do whatever it takes to prevent the People’s Republic falling into a recession, believing such an event would be a massive threat to internal securitiy. The party is aware that a recession would cause massive social and labour market disruption, but also limit its chance of retaining power.
Bilden also reminds distant LPs that Asia remains a very heterogeneous market which “will remain a challenge for investors sitting in London, Boston or California; it is difficult for them to figure it out.”
There are, for example, major discrepancies between the more and less developed parts of the region. For example buy-out opportunities are part of the investment mainstream in countries like Japan, Taiwan and Australia, whereas they are extremely thin on the ground in place less developed economies like India and China.
Axa’s Florin predicts developed parts of the Asia-Pacific region will bear the brunt of the current crisis, with their less developed counterparts more immune. “The financial crisis will make countries like Australia and Japan slow down a lot and cause a freezing of the buyout markets there,” said Florin. “However in India and China, the banks’ reluctance to lend should ensure that private equity remains an attractive option for entrepreneurial businesses to fund their growth.”
He also detects “some potential opportunities” in Indonesia, partly due to the fact it is the region’s third most populous country and that the government has become more stable. He also has a penchant for Vietnam, which he believes, although currently underdeveloped from a private equity perspective, will emerge as a more attractive proposition in time. Countries he is less keen on include Thailand, (“ too politically unstable to be of much interest”), Malaysia (“too small and tough”) and Korea (“too complex”).
The biggest danger to future private equity returns in the region is likely to be the industry’s own exuberance. “There’s a real danger that the industry fails to learn from the mistakes of the past,” says Florin. He believes, given the wall of money that is bearing down on the region, GPs are going to have to show some self-restraint, particularly where fund sizes are concerned.
“Some managers are going from US$100m funds four years ago, to $300m funds two years ago and now moving onto $1.6bn fund,” says Florin. “Not all GPs appreciate that requires a totally different business model.”