Redefining risk in Asia

Limited partners are wrong to think that Asian private equity portfolios should deliver a premium over Western markets because the risk is categorically higher. It is not.

Markets like Singapore and Hong Kong have infrastructures that are superior to many cities in Europe and Western Europe.

Many international investors who have committed capital to private equity “in Asia”, or looking to do so in the near future, are fond of saying that what they hope to achieve is a “risk-adjusted return”. The question is, just how meaningful a stipulation is this. Not very, I'd surmise.

For a start, Asia as a geographic concept is vast, home to more than half the world's population and socially, politically and economically diverse. As labels go, “Asia” is in fact pretty lazy.

Most people who have been to at least two Asian countries will agree that the region is far from monolithic and that the risk associated with investing in, say, China just isn't at all the same in Japan, India or Singapore. Even within China, conditions along the coast are radically different to the poorer inland provinces, so that the risk investors take on in different parts of the country has very local connotations.

The other problem with the quest for risk-adjusted returns out of Asia is the implicit assumption that because it is Asia, risk will inevitably be greater than elsewhere and can only be justified if a suitable premium over returns in the West can be generated.

Surely this is simplistic. Depending on where you are in Asia, there is no reason to assume that a risk premium should be available. Markets like Singapore and Hong Kong have infrastructures that are superior to many cities in Europe and Western Europe. They also have transparent legal systems and regulatory regimes that favour foreign investors. In other words, these markets are at least as efficient as many of their Western counterparts, so the idea of a risk-adjusted return simply does not apply.

In June, this theme was revisited at a real estate conference in Singapore. Pitero Doran, founder of a Korea-focused private equity real estate fund, went a step further to argue that limited partners with a global perspective should absolutely insist on risk adjusted returns – just maybe not in Asia. He noted that given recent events in the US and Europe, where the credit crunch has been driving down valuations, injected markets with massive uncertainty and stifled economic growth, perhaps it is in Western markets that investors should insist on a premium to compensate for greater risk.

The point here is not to suggest that investments in certain parts of Asia cannot outperform. The point is to say that when they do, it isn't necessarily because the underlying risk was greater. It may simply be because many markets in Asia currently have greater momentum, and economic growth to boot.

Doran's chosen field of private equity real estate illustrates this perfectly. In many Asian markets, the property boom is showing no signs of abating. As a result, there is still a vast range of attractive opportunities for investors to pursue, from gaming resorts in Singapore to new townships across India, let alone the ongoing race for the world's highest buildings in the Middle East.

Well-selected and competently executed investments in all these areas are bound to yield attractive returns. But to describe them as “risk-adjusted” would be misleading. And let's not throw them all into a pot labelled “Asia”.