Ask US asset owners about their paramount concerns, and their answers will resonate their peers in other regions: they worry about low interest rates and investment returns.
Over half of the world’s investment grade bonds – mostly sovereign debt – are trading at negative interest rates, leaving US investors concerned about whether negative rates in the US are a real possibility.
That’s a new situation for investors and one that is seriously concerning. And it has caused many to focus their attention in a new direction.
“When a sophisticated asset owner looks at the current situation, they see a lot of deflationary pressure,” said Rich Nuzum, president of the wealth division at Mercer in New York. “In that environment, where do you get a positive investment return? Thoughts turn to Asia and to private market asset classes.”
While there is no firm data about such flows, most family office representatives that AsianInvestor spoke to had the same opinion.
Despite this appeal, a combination of governance requirements or other limitations has thus far prevented many of the US’s institutional investors from chasing private asset investments in Asia.
A typical defined contribution pension plan in the US, for example, will mainly focus on target date funds that mostly invest in developed market long-only assets, according to US health and investment consultant Mercer. Such funds are likely to cap their weighting to emerging markets, or even hold an underweight position because of a natural home bias. Private markets investments in Asia are just not on their radar.
Instead, family offices comprise the fastest growing US investor segment in the private markets space.
“Families in the US have recognised there is a private equity opportunity in Asia, investing with managers on the ground,” said Michael Zeuner, managing partner of New York-based advisory firm WE Family Office, which has $11 billion of assets under advisory. “It’s clear to us that what is going on with regard to the economic and demographic development in the region makes it very attractive for future growth.”
PRIVATE EQUITY FOCUS
Family office investors aspiring to build private asset exposures to Asia often start by looking to private assets. In particular they may begin by buying into private equity funds, or they may look to infrastructure or real estate.
They typically use the assets as a substitute for developed market equity or fixed income, and might place as much as 80% to 90% of their money in private markets, in an expectation of earning returns of about 20% a year.
“Instead of investing in sovereign debt and getting close to zero yield – with the chance that if rates do rise they get crushed on a marked to market basis – they’re going to lock in cashflows for a real estate or infrastructure investment,” said Nuzum.
WE Office’s Zeuner has a similar approach. “The trend for companies to stay private for longer is very much why from a macro perspective we recommend deploying more capital into the private markets,” he said. “Precisely because by the time they become public, a lot of the value has already been created.”
It takes a degree of sophistication and a lot of work to find and diversify private assets in the region, even if the family investor invests alongside general partners (GPs) in a target location. Many lack such expertise but are trying to acquire it, as they look to gain the comparative advantage of Asian knowledge.
“We see family offices and sovereign wealth funds in particular upscaling their in-house investment staff and partnering in different ways with GPs to access investment opportunities,” said Nuzum.
While families are looking for access to budding opportunities, they still have their preferences. Zeuner said the family offices understand real estate, for example, but that they typically avoid overly structured or financial engineered investments.
“They want to buy an asset and they expect the manager to add value. The way they made their wealth was through operating companies, so they are comfortable in that space.”
Michael Felman of New York-based family office MSF Capital Advisors is another believer in private assets in Asia.
“My own family have started businesses in China and Korea and we are pretty active in Asia – all direct, private equity and real estate investments,” he told AsianInvestor. “We were early investors in private equity fund manager Cathay Capital. Everything else is direct and we own a lot of real estate in Beijing and Shanghai.”
MSF is also invested in Korea, Hong Kong and Singapore and it is looking closely at Malaysia too, with a view to bringing co-investors from the Middle East to support its growing Islamic finance market.
In Zeuner’s view, Asia as a geography is only going to gain importance among US-based wealthy families, as they focus more of their emerging markets exposure on it.
“I would expect to see that mix shift increasingly from Latin America and other emerging markets,” he said. “I would say there has been a dramatic shift.”
This momentum has been slightly dampened by concerns over the current geopolitical overlay, and especially the escalating trade war between the US and China. However, Zeuner said “China still represents an investment opportunity and there is probably more room for private companies to manoeuvre”.
Asia looks particularly appealing when considering a background of a relatively high valuations in developed markets and particularly in the US.
“What we’ve seen in the past couple of years is a lot of capital flowing into the private credit space in North America and Europe and we’re very concerned that valuations are high,” said Zeuner.
He added the family office has followed three key themes since the beginning of 2019: environmental, social and governance (ESG), Asia and private markets.
“That would typically be a combination of public and private markets exposure. We think about credit, real estate and equity as three distinct categories. With markets like the US, we are more focused on passive exposure because it’s very difficult for managers to generate alpha. In emerging Asia it’s going to be more through active managers.”
Felman noted that another macroeconomic investment opportunity is Chinese healthcare, given both the country’s aging population and increasing wealth.
This article was adapted from an original feature that appeared in the Autumn 2019 edition of AsianInvestor magazine.