What is Paul Capital’s mandate?
We were set up in 1991 in the US by Philip Paul who had the opportunity to acquire a portfolio of venture capital and leveraged buyout fund positions. We were a pioneer in the secondaries market, which essentially means we acquire interests in private equity funds, direct private equity interests and unfunded private equity commitments. We currently manage $7.3 billion of assets. In Asia, also, we were the first dedicated secondaries fund when I joined Paul Capital in 2008.
What kind of deals do you seek?
Our sweet spot for secondaries deals is in the range of $50 million to $100 million, although in Asia, given smaller deal sizes, we could go lower. We do both sole deals and club deals. We generally don’t do single-asset deals because we seek diversification in the portfolios we buy.
How do you originate your deals?
The secondaries space on which we focus is very much an emerging market within an emerging market in Asia; that is there are no intermediaries, unlike in the US where some investment banks have dedicated teams servicing funds such as ours. What this means is there are no auction deals.
This actually fits the philosophy of Paul Capital and plays well to our strategy. We like to create tailor-made, situation-specific solutions that work for us and for the seller. I’ve worked on the buy-side in private equity for more than a decade and many of the deals we source come to us through my network of relationships.
How do you cash out of your investments?
We don’t trade our portfolio. We raise money from the usual suspects — endowment funds, pension funds and family offices mostly out of the US, some out of Australia and Japan. One of the main reasons investors buy into secondaries funds is visibility and consequently faster payback. We could buy into a fund when it is three, four or even five years into its life.
We return money to investors when the funds we buy into are liquidated. I would say secondaries funds are more IRR [internal rate of return] focused than primary investors.
What is unique about your business in Asia?
In Asia, investors have a cultural bias against being seen as sellers. So our credibility as a buyer and ability to be discreet are critical. Also, we can offer myriad solutions to resolve liquidity issues such as upside sharing, joint ownership of a portfolio or Paul Capital agreeing to take up the unfunded obligations of a portfolio.
Did the subprime-sparked financial crisis create a good supply of deals for you?
From 2006 until mid-2008 private equity investing the world over was easy and investors were flush with funds. This turned upside down in late 2008 and there was a flurry of potential sellers seeking liquidity, for example, some of the large US universities put up $1 billion-plus portfolios for sale.
Looking back, though, the amount and number of secondary transactions that closed at the time was less than expected. Since the early part of the last decade around $20 billion of secondaries deals closed annually. In 2009 only 60% of that closed. One reason was the fairly quick bounce-back in sentiment, which made it difficult to bridge the valuation gap between sellers and buyers. Actually, we closed more deals last year than we did in 2009.
How are proposed regulatory changes in the financial services industry changing the competitive arena?
In the aftermath of the crisis, things like the Volcker Rule have caused a number of financial institutions to rethink their private equity business. Some banks such as HSBC have spun out their Asian private equity management team. Others are winding down the business. Captive GP teams (or private equity management teams) in banks are proactively reaching out to us as they are nervous about the continued support of their parent institutions for proprietary investing.
Increased capital requirements and requirements to mark-to- market are also making banks rethink their private equity business. Finally, as banks wind down their leveraged finance businesses there is not as compelling a reason for some firms to be in private equity investing.
As someone who has been both a direct private equity investor and now manages a secondaries fund in Asia, how have you seen the market develop?
When I started in this industry in the mid-nineties the competition was very different and only a handful of those players exist today. The first milestone of change was the Asian financial crisis, which forced Korea to open its doors to private equity. Many private equity firms made a lot of money in Korea at the time.
By the middle of the last decade there was a proliferation of private equity players in Asia, including both traditional funds and opportunistic players such as hedge funds, attracted by how easy it was to raise funds. But some of them have not been able to close a second round of fund-raising in tighter liquidity environments. Investors in Asia now seek strong differentiation to commit their money to a fund manager.
The wave of consolidation underway in the private equity industry is healthy and inevitable. Investors will see the emergence of top-quartile fund managers who have survived both up and down cycles.
This article first appeared in the March 2011 issue of FinanceAsia magazine