Asian LPs have become part of the landscape of European private equity, pursuing opportunities across buyouts, secondaries, credit and distress. But what do they really want from the region?
“When Asian investors rank the regions of the world by attractiveness, Europe sits a distant third after the US and Asia,” says Enrique Cuan, managing partner at placement agent Mercury Capital Advisors.
Europe’s financial woes, which have dragged on for years as central bankers rush to plug the weakest parts of the dam for fear the cracks might spread and release a torrent across the entire region, do not appear to be ending. Even though the markets may have bottomed out, there is a sense among investors that the private equity opportunities of today will still be there in 2014. “Why should we buy now when we can wait?” Cuan asks.
In this context, European managers are seen mixed success raising capital from Asia over the last 18 months. There are few funds in the market that qualify as “must haves,” and it is only these established players with superior performance that have managed to get meaningful traction in the region. And with LPs in other parts of the world reducing their GP relationships, if not their exposure to the asset class, when Asian LPs do back a European fund they account for a larger share of the corpus than in previous vintages.
This trend arguably first became apparent in October 2011 when EQT Partners closed its sixth fund at EUR4.75 billion ($6.5 billion). Asia Pacific investors contributed 23% of the total capital, compared to 7% in the previous vehicle; it was no coincidence that the sovereign wealth fund share rose from 31% to more than 50%.
The following year BC Partners had a similar experience as it closed its ninth European fund at EUR6.5 billion. Asian and Middle East investors accounted for 30% of the corpus, up from 10% the last time around, while the sovereign portion more than doubled to reach 25%.
“Success is very much driven by a combination of timing and performance. If many investors are looking to invest into Europe and the performance is top then the funds will be popular,” says MounirGuen, CEO at MVision, another placement agent. “In the past few years the region was not a focus area due to economic headlines but it is now picking up again, especially at the larger funds end.”
Incentives are clearly in part responsible for this pick-up. While the 2/20 fee structure may be holding reasonably firm in Asia – at least for now – in Europe it is crumbling. BC Partners is said to have offered a 5% discount on fees for investors making large commitments ahead of the first close. It is a practice widely employed by other GPs in the region, alongside numerous other incentives, ranging from transaction fee waivers to co-investment opportunities.
Yet Asian interest doesn’t begin and end with buyout funds. Industry participants say there in an appetite for exposure to Europe through more niche strategies focusing on credit, secondaries and distressed assets. It begs the question of what is behind this agenda.
First and foremost, the nature of an Asian institutional investor’s interest in Europe depends on the maturity of their program. If an LP has been committing to private equity managers for two decades or more, it will likely have a number of existing European relationships. Changes might be made to the portfolio depending on the interest in large-cap or mid-cap companies and, as part of that, there are usually decisions on altering geographical allocations.
However, two thirds of the sovereign wealth funds investing today were not around 10 years ago. While Government of Singapore Investment Corp. (GIC) could have 100 or more GP relationships, its younger regional counterparts – China Investment Corp. (CIC), Korea Investment Corp. (KIC) and Malaysia’s Employees Provident Fund – would have only a fraction of that exposure.
For example, in 2009, KIC’s private equity activity was virtually non-existent. In just under three years, it had invested about $10 billion on a committed capital basis across a spectrum of alternative investments. The danger is trying to move too quickly, deciding that alternative investments must account for a certain portion of overall assets and then allocate a growing amount to an ever larger number of GPs.
“While older programs might look to reduce relationships, the new ones may be only half way through their European program. Therefore, they will look to increase their relationships on a very selective basis,” says Guen.
The other potential drawback of a rapidly implemented program is that the investor ends up with a large basket of funds from similar vintages. A desire to temper the J-curve effect on a portfolio – essentially waiting 3-4 years for deployed capital to start generating returns – has led numerous Asian LPs into secondaries in recent times.
Adams Street Partners, StepStone, Deutsche Bank and LGT Capital Partners are among those to have raised secondaries-focused funds in the last 18 months, each one ending up oversubscribed. Referring to LGT’s Crown Global Secondaries III vehicle, which closed at $2 billion in February, one industry participant remarked that a significant number of Asian LPs had committed capital, perhaps with one eye on their European exposure.
There is also demand for credit strategies in the region as private capital is used to meet the borrowing needs of companies that are having difficulty sourcing financing from the banks or capital markets. Partners Group raised EUR375 million for a senior loan-focused private market credit strategies fund and private debt mandates last September.
Martin Scott, a managing director at the firm, noted that demand is being driven by macro debt issues in Europe and around the world.
“As a result of this, exceptional terms are being achieved in the credit space, for both senior and mezzanine debt positions, more so in Europe at the moment,” he explains. “Investors are wary, though, about how long this abnormality, where you can achieve equity-like returns for debt risk, will last. In this regard we give clients access via a strategy that looks to invest in 12 months and have their money returned to them in five years, it’s almost like mirroring a typical bond, but in private markets debt.”
The idea that there is a macro opportunity out there to be capitalized upon is also behind Asian LPs’ desire to enter the European distressed space – entrepreneurs are in trouble and therefore assets can be picked up at bargain prices. However, what makes sense in theory sometimes doesn’t work out in practice. Industry participants say there is limited exposure to distress among Asian institutional investors, citing the paucity of managers with deep track records and strong brand names.
“Distressed investment opportunities are always music to investors’ ears, but there aren’t many specialists in this area on the private equity side,” says Markus Ableitinger, managing director at PE-focused asset manager Capital Dynamics. “As far as direct deals are concerned, it is relatively rare for Asian LPs to get involved, with the exception of sovereign funds that have buyout power or a number of people behind them.”
It will take 12-18 months, once deal flow out of the European market becomes clearer, to see whether these strategies are likely to pay off, whether it is credit, secondaries, distress or big buyouts. The long-term trend that will likely continue to gain momentum regardless is the larger Asian LPs’ desire to develop in house capabilities.
In this sense, exposure to Europe should be seen in strategic terms. Co-investment alongside a buyout fund allows large checks to be written at a lower cost in fees, but the primary motivation is getting close to deal flow with a view to ultimately going direct.
Last year Chinese investment into Europe reached $12.6 billion, up 21% over 2011, according to A Capital, a private equity firm focused on cross-border transactions involving Chinese companies. China Investment Corp. (CIC), the country’s sovereign wealth fund, was the most active investor, picking up stakes in London’s Heathrow Airport and UK utilities major Thames Water.
Speaking at the AVCJ China Forum last week, Olivia Ouyang, managing director of the private equity investment department at CIC, noted that Europe is attractive for Chinese investors because there is no integrated approval authority, unlike Canada, Australia and the US. She expects outbound investment to continue apace, led by state-owned enterprises in search of resources, but with a degree of interest in areas such as financial services and consumer brands.
“Chinese investors want to diversify their exposure from China and gain a competitive advantage over their competitors at home, such as a brand or the technology that goes with it,” adds Andre Loesekrug-Pietri, A Capital’s chairman and managing partner. “Look at Sany Heavy Industry’s investment into German heavy equipment manufacturer Putzmeister and Geely’s investment in Volvo in Sweden.”
But he warns that assets aren’t as cheap as many investors might think and there is still competition for them among local companies, buyout funds and large family offices. For example, Fosun International, which has positioned itself as an acquisitive conglomerate, has only done two deals in the past three years, and this is a strong showing by most standards.
“Our approach is sourcing strong brands in Europe where profitability is squeezed by the economic slowdown, and providing new direction for development in China,” says JiannongQian, general manager of Fosun’s commercial investment department. “We gain strong market exposure in China and I believe we could create value to the European brand.”
This is a solid thesis but it is predicated on managing the target company and turning it around. Not all LPs with an appetite for direct investment have this capacity, which suggests they are best served operating in partnership with others or limiting themselves to passive, minority stakes. In short, it will take time for this approach to be realized successfully on a broad scale, by Chinese and other LPs in emerging Asia.
In the meantime, European private equity firms must take note of the larger LPs’ appetite for co-investment and tailor their marketing efforts accordingly. They are still in a position to secure fund contributions, but the focus should be on establishing themselves as relevant – as brand names with interesting deal flow.
It is a game for those with scale. “As for first time funds, they’re better off spending their time elsewhere and not getting on that long flight to Asia,” Mercury’s Cuan says.
The likes of EQT and BC have the resources at their disposal to mount aggressive investor relations initiatives, putting people on the ground to tell their story. And it is important to touch base with these clients frequently. KKR, The Blackstone Group and The Carlyle Group have small armies of IR executives, setting up calls with deal partners, putting out quarterly reports and conveying tidbits of information in between. As one fund manager puts it, this is about “being perceived as creative, visible and alert.”
“European GPs should spend more time cultivating local relationships after fundraising – you need a dialogue with Asian LPs during the off-season for fundraising,” adds Vincent Ng, a partner at placement agent Atlantic-Pacific Capital. “Given the local European fundraising environment has been a lot more difficult in the last five years, a lot more effort is going into communication with overseas investors.”