David Pierce has a 20-year career in private equity in Asia. He joined HQ Capital in 2014 to run its Asia business. HQ Capital is the investment vehicle for the heirs of German industrialist Harald Quandt and was formed from the amalgamation of several alternative investment units in 2015. Its roots go back to 1989 when it began to invest in US alternative assets, first for the family and then for other German family offices and institutional investors; it has invested in Asian private equity since 1997. Pierce, who previously ran Squadron Capital (now a unit of Flag Capital Management), met with Jame DiBiasio to discuss HQ's strategy and the outlook for PE in Asia.
What is your emphasis in Asia: primary investments such as doing buyouts, trading secondary assets, or co-investing along with GPs?
We have a commingled programme to combine these activities. The allocation is a similar proportion to what we do in North America and Europe: we have about a quarter of the portfolio in secondaries, 10% to 20% in co-investments, and the rest in primary. Primary PE creates returns but deals take longer, secondaries give us a stable cash flow early in the fund cycle, and co-investments reduce the overall fees that we pay.
Secondaries in private equity are still unusual in Asia.
Yes, there are few players in Asia in this segment of the market. We have a dedicated secondary programme for the region now.
Is this to buy assets from investors in funds (limited partners)?
That’s part of the programme. Many LPs want to reallocate their portfolio. That is the traditional definition of secondary private equity. But we also have a growing area in our portfolio that is direct secondary investments, in which we buy a single asset from an LP or help reconstitute an existing GP. For example, a global fund may need to refocus or have a need to divest itself from positions in Asia. We can help their local team managing those assets become established as an LP and buy the existing assets from the departing shareholder.
You’ve transacted such deals in this region?
More than you’d think. It’s opportunistic but we can serve as a catalyst to make this happen; we can act for a GP that needs help to extract themselves from a situation or get a hold of liquidity if they are unable to return capital to their LPs – for example, when IPO markets are shut but the GP is required to distribute capital back to the investor.
And the China IPO market is shut.
Even when it’s open, it is still difficult for smaller funds to access it. The queue is long and there is a lot of opacity around how to get on it.
In public markets, at least, the past six to eight months have seen record outflows from emerging markets. What impact does that have on private equity?
On the traditional securities side of the market we see investor fatigue and a reallocation back to core exposures. For whatever reason investors came out from the US or Europe in the last decade and made two or three private investments and they have now decided to sell. It could be a function of a maturing of the industry. There was a lot of enthusiasm about Asia a decade ago, it was new and shiny and investors placed bets on a new crop of GPs. Some of these bets did extremely well. Some did not do well at all.
Is regulation also a factor? The world has changed since 2008.
Yes. LPs may also face regulatory issues, such as the Volcker Rule, that have come along since they made their commitment.
These are structural issues. Does volatility in public equity markets matter?
It plays into consideration. The promise of rapid growth and fabulous returns from Asia hasn’t come true. Instead we see Chinese and other Asian capital going out of the region. This is not a driver of selling by Western LPs but it is a source of demand for secondaries. For these new players from Asia it’s a way to get a primary portfolio going and to develop knowledge about investing in private companies without needing a big J-curve and having to incur a significant initial loss. Money leaving Asia for the West may mean there is less capital available for local GPs but it will also produce deals in which GPs address that problem.
So this is really boosting the market for secondaries.
The real driver for secondaries has been overdependence by GPs on IPOs for exiting their positions. It was never plausible that every company in the portfolio would get listed but many entrepreneurs had that dream.
All emerging markets have suffered from capital outflows, so public offerings through emerging markets are few and far between, usually limited to bigger companies that don’t have private-equity backing. These days even good companies struggle to get listed.
When China or Southeast Asia IPOs become difficult, does that mean you shift more capital to Japan or Australia?
Those markets are steadier and tend to be controlled buyout markets. I’d include Korea as well. GPs can decide what exit to take, such as a trade sale. These countries allow GPs to take majority ownership.
But the preponderance of investment in Asia is still for minority investors into growth capital, and in that situation the local entrepreneur may not share the GP’s long-term aspiration.
In the second part of this interview, Pierce reflects on what has and hasn't changed over his 20-year career in Asian private equity and looks at the prospects for PE in China.