Why ECM buoyancy is a double-edged sword for Asian PE

The chance to turn paper profits into hard cash is a boon for the region's private equity funds. But the opportunity for major investors to make money elsewhere weighs against them.

For Asia's private equity fund managers, buoyant global markets should offer an ideal opportunity to cash out and turn paper profits into the real thing.

But life's never simple. After all, markets are equally attractive in the West, and many global institutional investors are less likely to venture into Asia at a time when they can enjoy healthy returns at home.

“One of the challenges in some parts of private equity market in Asia is value realisation – there are many funds that have shown very substantial mark-ups in their portfolios but are not necessarily in a position of realising them,” Brian Lim, Hong Kong-based partner of Pantheon Ventures, told FinanceAsia in an interview last week. The global investor had $36.9 billion AUM as of the end of June last year, for private equity primaries, secondaries and co-investments, as well as infrastructure deals.

One case in point is the venture capital market, where a fair amount of capital that's sitting on very sizable but as-yet unrealised gains, Lim added.

Asia’s rate of distribution lags the global rate of distribution, according to data gathered by private markets investment adviser Hamilton Lane. Annual distributions from Asian private markets funds has dropped from over 20% in 2015 as a percentage of net asset value, to around the mid-teens in 2017 [See graph].

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But while exiting investment has proved challenging, booming capital markets in Asia and elsewhere are changing the picture.

“Many have plans for realisation in the public markets, whether that’s in Hong Kong, New York, or elsewhere,” Lim said, though he declined to name specific fund allocations or direct investments Pantheon has made in Asia.

In the China portfolio alone, a line-up of Chinese tech IPOs are already firmly in motion. That includes the long-awaited public offering by Xiaomi, the world’s third largest unicorn. VC firm Qiming Venture Partners backed Xiaomi in its Series A round in 2010 and Series C round in 2012, respectively. And Douyu TV, a Sequoia Capital-funded company in China that streams footage of people playing video games, plans to list in Hong Kong this year.

Additionally, the secondaries market in Asia's private equity sector is also maturing. That means increased opportunities for small funds to sell their stakes to bigger funds, creating another exit route, Lim added.

As a sign of investor appetite in Asian secondaries, among the 38 private equity secondaries funds tracked by alternatives data provider Preqin, approximately 10% are now focusing on opportunities in Asia. This figure had been negligible in the past.

On the flip side, Asian houses’ fundraising is being clouded by the eye-catching performances of both public and private markets elsewhere in the world. Many key limited partners – as private equity investors are known – are western-based.

“Given the state of the US markets where both the public and private equity market have done very well, and that quite a lot of Asian private equity money comes from US and European LPs, I think many LPs have it found it easier to just stay in their own backyard and allocate capital there. So in that context, capital has been harder to come by for many private equity groups in Asia,” Lim said.

US stocks delivered a 21.90% return to investors last year as of December 29, according to MSCI USA Index, which covers about 85% of the free float-adjusted market capitalisation in the US. That rate of return appears more appealing than the 18%-20% range PE funds used to aspire to, but nowadays find it challenging to deliver amid fierce competition and high valuation.

To be sure, the last 12 months has seen an extremely successful fundraising momentum for fund managers in Asia amid ample market liquidity, and some marquee names have closed large-ticket funds in a short time. For example one of the most well-known private-equity firms in Asia, Affinity Equity Partners, started to approach investors with plans to raise $5 billion in August and recently closed the fifth buyout fund at $6 billion.

But that means fundraising is entering a two-tier market – established houses will have little trouble finding money, but a very large proportion of other funds will face a difficult time raising capital if liquidity is pulled away. The overall trend general partners – what PE fund managers call themselves – have seen from LPs is “larger commitments with fewer relationships,” Alexander McCloskey, head of investor relations and business development at Falcon House Partners, told HKVCA Asia Private Equity Forum 2018.

Stuart Schonberger, managing director at CDH Investments, one of the oldest alternative investment fund managers focused on China, was also on the panel with McCloskey. And the past year "is probably the best fundraising environment I've seen since 2007," said Schonberger, who was one of six co-founders of CDH in 2002. It has been gearing up to raise a new fund over the past 12 months.

Schonberger also cautioned, in line with Lim's view, that "because [the PE performance in] developed markets, especially the US, has been so strong; and the public markets around the world have been so strong, the questions of 'China risk premium' and 'liquidity versus illiquidity' have come back - those were the issues that seemed to have gone away a few years ago, but are quite relevant now".

All that said, however, Lim emphasised his fund was not reducing its allocations to Asian private equity. “Over the long term, we are still quite bullish on opportunities for PE to make attractive returns in, for example, China,” he said.

Pantheon now has approximately $4 billion of its AUM in emerging markets, mostly in Asia, with China, Australia and India as its core Asian destinations, according to Lim.

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