Private debt continues to gain interest around the world and many Japanese investors have begun looking into the asset class or have made their initial commitments, delegates heard at Private Debt Investor’s first Tokyo Forum.
There is likely to be little fertile ground left for managers in the US and parts of Europe, where many institutional investors have made their initial commitment to the asset class and become quite sophisticated about it in the process.
However, Japan may be a new source of capital for GPs. Many credit managers have established outposts in Tokyo in recent years, and Japanese investors’ understanding of the asset class has deepened.
Here are three of our takeaways from the Forum for GPs about Japanese LPs.
From an alternatives allocation standpoint, this could be just the beginning
Total alternative allocations in Japan are still low when compared with the amounts allocated by US and European investors. Many pension funds have an allocation target percentage of around the mid-single digit mark for alternatives – across private equity, real estate, private debt and infrastructure.
But many remain far short of that target and some have yet to even make significant investments into private equity.
The Government Pension Investment Fund – one of the largest pension funds in the world, with the yen equivalent of $1.46 trillion in assets – is still building out its alternatives programme. The fund has a maximum allocation of 5 percent, but currently only has 0.26 percent invested in alternatives.
Although it has a co-investment operation that focuses on emerging markets, the firm has just put out an RFP for its first initial private equity manager. This will be a fund-of-funds structure like its real estate and infrastructure commitments.
One US-based manager raising a follow-on direct lending fund noted that, in the current fundraising round, the firm was making a concerted effort to reach out to small and medium-sized Japanese LPs. The source noted that the firm had received enquiries from this constituency.
Japanese investors run a thorough due diligence process
One US-based global firm that has had LPs in the country for almost 15 years noted that Japan’s investors run a “rigorous due diligence process upfront”, but can be loyal LPs thereafter.
A Japanese investor said their fund commitments came not from a manager’s pitch but from parsing through the firm’s loss record. The LP wants to know what happened in each circumstance where capital was lost and how it would be different next time. Another said they look to meet with a GP’s team that is responsible for the workouts and turnarounds.
Another concern voiced was style drift. One pension fund investor building out their alternatives allocation said that when carrying out due diligence on firms, what separated managers from one another was whether they could stick to the investment philosophy they had outlined. This person noted the fund would not put money with a manager that had a history of style drift.
Return targets and hedging costs can determine where LPs put money
Currency hedging and the costs associated with it were on LPs’ minds. When investing in US dollar funds, the hedging costs can eat 2-3 percent into returns, while in Europe there can be little, if any, cost. These realities, alongside the return goals or requirements, can drive LPs to choose a leveraged or an unleveraged fund.
If an LP is looking for a mid-single-digit net return for a US vehicle, the investor would need to put money in a leveraged vehicle to achieve that after taking into account fees and hedging costs. If the LP were putting money into a Europe-focused fund, the unleveraged product would achieve the same goal.
A separate LP said that when managers offer a yen-based sleeve for hedging purposes, the investor will ask to see how, specifically, the manager runs its hedging operation. If the information is not readily available or a manager will not share it, the investor will hire a third-party advisor to evaluate the hedging programme.