The period following the collapse of Lehman Brothers in September 2008 will probably be remembered as one of the more difficult periods for the entire global private equity industry. As an LP investing in private equity in the aftermath, answering the following questions is what I believe to be most important at this time: What lessons have we learned from the downturn – and how should LPs construct their private equity portfolios in the future?
First, it is extremely important to continue to invest in the asset class if you can afford it. I firmly believe that deals done in this era will generally prove to be better investments than deals done during the leverage boom as a sheer function of lower valuations. Leverage and cheap credit is what pushed up prices in the last cycle, and those days of easy credit are gone for several years at the least. By the same token, LPs probably should not have invested as much in the recent boom, and hopefully we can spot the same phenomena when similar exuberance pops up again – as it undoubtedly will. Investing at a carefully measured pace will remain crucial to the long-term success of a private equity investor’s portfolio. This is also quite relevant in terms of, say, investing in Asian private equity, since capital can flood these relatively small markets very easily.
Second, it has been our belief that LPs should take a balanced approach to investing in private equity and strategy/style diversification is important. While one probably needs to make adjustments to beat the median return and there is no magic portfolio allocation formula, betting too much on a particular strategy has proven yet again to be dangerous, no matter how good that strategy may appear to be at the time according to common wisdom.
Third, along those same lines, Asian private equity should probably increase in prominence as a component of a private equity investor’s portfolio. I probably do not need to remind everyone that the Asia-Pacific region is one of the regions faring best throughout this financial storm.China in particular has performed strongly and India, with its young growing economy, also appears to be growing strongly. . My general suspicion is that with the current positive macro conditions, even for some of the more difficult vintages in the past, quite a few Asian private equity funds will have realized pretty competitive returns on a global basiswhen we look back several years from now … We will see.
The trouble with Asia
I cannot find too many bad things to say in a macro-sense about Asian private equity. The problem though is that private equity is probably not an asset class where you can successfully invest with a mere general thesis. Private equity is too complicated and too idiosyncratic and investing with a general thesis can get you into deep trouble (remember the dot-com boom and bust?). Moreover, unlike, say, Europe, the cultural divide within Asia is much greater, and every country is distinct, having its own peculiarities. Here are some of the issues that concern us in particular when we are looking at Asian funds.
1. Cultural resistance to private equity backed by foreign capital: Will foreign LPs investing in private equity in those countries be treated fairly or be placed at a competitive disadvantage compared to domestic LPs in areas such as taxation and investment opportunity?
2. Lack of control: Many investment strategies in Asia are growth capital oriented and lack control. The LP will need to carefully assess whether the GP really added value or exercised adequate control over their portfolio companies.
3. Instability of GP teams: The private equity industry is quite young even in the developed world but even more so in Asia. This may be a bit biased, but we seem to see serious team issues at Asian GPs more frequently than at our US or European GPs. This may be a function of there being less established players, but in any case we sense a heightened risk level.
More specifically, how do we view each of the major Asian private equity markets?
1. China: We are likely to increase allocations to China due to its prominence and sheer size. I am wary, like any other foreign investor, of the RMB fund issue, and if we feel we are being burdened by too many competitive disadvantages or that we are being treated unfairly, our positive view may change. The general tendency of the Chinese market to overheat is also a cause for concern. Moreover, I think fraudulent behavior and irregularities at the company level remain serious issues in this market. Striving to find GPs capable of investing at reasonable valuations and avoiding the disasters will prove to be crucial in the long run.
2. India: We are positively inclined to invest more in India, but the market is smaller than China and control may be even more of an issue here, perhaps because there are so many family-owned companies. Many GPs have experienced team issues here as well and that concerns us.
3. Japan: We are generally bullish about the Japanese private equity market. It may sound like hometown bias, but it isn’t since we have allocated only a small amount of capital to this market thus far. I am not at all satisfied by the recent past performance of most of the leading managers in the market. However, I believe chasing past returns is a dangerous act and am not yet convinced that the Japanese private equity market is a structural underperformer. The track record is too short to formulate a reasonable judgment on the market as a whole and therefore one can still only make predictions about how this market will develop in the future. A comforting fact is that the legal system and financial infrastructure are – though far from perfect – solid and transparent. It is probably one of the most difficult markets in terms of deal sourcing, but I am generally inclined to favour markets where valuations have come down (which they have) and where there is not too much competition (it has abated somewhat in
Japan). There should be interesting opportunities down the road but the problem is that I really cannot prove it. I can probably say though, that contrary to the overall economic picture, mid-sized companies in Japan with secular growth themes do exist. The question is whether you can find GPs that can really get a hand on them. I also very much hope that, although we are domestic, foreign LPs be treated pari-passu to domestic LPs from a taxation perspective. Hindering the flow of capital from investors is probably unnecessary and could prove to hurt the competitiveness of Japan as a country in the end.
Besides the above, we are generally bullish on Southeast Asia and Australia. All in all, Asian private equity is probably a strategy that should be emphasised further in the future by private equity investors, because Asia has high macro-economic growth; desirable when seeking to achieve financial gains and a trait the developed world sorely lacks. However, LPs will still need to do their homework, and perhaps even more carefully for Asia, because of some of the issues I have highlighted above. After all, in Asian private equity, choosing the right GP at the micro level should prove to be the most crucial factor, just as in any other market.
• Hideya Sadanaga is the Deputy General Manager in the Credit and Alternative Investment Department at Nippon Life Insurance Company. He is based in Tokyo.
Nippon Life Insurance
Nippon Life Insurance Co. Ltd is part of the Nissay Group, an international insurance and asset management group with offices in Asia, US and Europe. In total, the group manages more than $500 billion in assets.
Nippon Life Insurance is an experienced investor in the private equity sector having started investing in the asset class in the mid-1970s. The corporation has a total exposure of $2 billion in around 110 private equity funds including buyout, venture, mezzanine, secondary, turnaround/distressed and other funds.
Nippon Life Insurance commits to private equity funds investing in North America, Western Europe, and the Asia Pacific regions. They invest in about 15-20funds annually and buyout and venture capital funds make up about 75% of their portfolio.