Institutional investors are finding it increasingly tough to partner up with leading PE funds to make big investments in Asia, and large ones are instead considering more direct investments, say experts.

The level of investor demand is allowing PE firms to pick and choose whom they want as limited partners (LPs), or investors into their funds. That has led investors without strong relationships with the companies to struggle to invest as much as they would like.

“A number of successful PE fund managers, especially those of high institutional quality and a proven track record, see their funds being oversubscribed and need to take into account the strategic value of LPs when deciding allocations,” Shirley Ma, director of private equity in Asia for MetLife Investments Asia, told AsianInvestor.

PE funds, also known as general partners (GPs), often scale back investments of LPs, but the sheer volume of demand in Asia has meant they have had to be particularly aggressive, she added.

Asia-focused private equity firms held around $558 billion in total assets under management (AUM) as of June 30, 2017, according to alternative assets data provider Preqin. This included $184 billion in dry powder, which is money that has been raised but not yet invested, plus $374 billion in unrealised value.

The aggregate amount of capital raised by Asia-focused private equity firms last year was $66.2 billion, up around 13% from the amount in 2016. Asian PE returns for the one year leading to June 2017 were 12.3%, compared to 14.1% for the three years leading to June 2017.

Dave Brochet, managing director and head of Asia for Canadian pension fund Caisse de dépôt et placement du Québec (CDPQ), Canada’s second-largest institutional investor, said the “ticket size” issue even affected his company.

“Ticket size is an issue for us, both in terms of general partner commitments and for direct investments,” he said at a panel at the Asia Private Equity Forum 2018* held in Hong Kong on January 16.

CDPQ has a private equity portfolio of $25 billion, 5% of which is invested in Asia, Brochet added. However, four of its most recent PE commitments in Asia have all been scaled down because of these challenges.

The pension fund typically seeks to make private equity commitments $200 million to $700 million, but Brochet said investors hoping to invest $350 million in an Asia private equity fund might be scaled back to just $250 million.

Part of the problem is a lack of relationship, he noted. “In Asia, as a new investor, it’s challenging to deploy that kind of money when you are still building relationships with a local fund.”

This scaling back can negatively impact CDPQ’s PE strategy, which is to effectively take minority stakes of up to 30% in companies via funds, Brochet said.

Direct investments

The limitations on investment ticket sizes in PE funds is leading some investors to consider more direct or co-investments.

CDPQ is a good example: only 30% of its $25 billion portfolio is with GPs, with the rest being conducted through direct investments. The pension fund typically works with six GPs to co-invest in Asia, said Brochet.

In December 2017, private equity secondary market data provider Coller Capital noted in its bi-annual report that 31% of global LPs were making direct investments into private companies by the end of 2017, up marginally from 30% in 2012 and 17% in 2006.

However the percentage rises among large institutional investors. Ninety-two percent of large LPs in Asia were engaged in direct investments or co-investments at the end of 2016, versus 74% in 2012, according to a survey in Bain Capital’s latest Asia Pacific Private Equity Report, released in March 2017. It defined ‘large LPs as investors planning to commit at least $500 million into private equity.

The same report said that 29% of all private equity deals in Asia between 2012 and 2017 involved some form of direct investment, while this rose to 57% when looking at deals worth $1 billion or more.

Zhan Yang, Hong Kong-based principal at Coller Capital, told AsianInvestor that the trend of direct investing is likely to stay most popular among investors of a certain size and specialist knowledge, who can execute a direct investment strategy.

"This strategy requires more investment professionals, with a different set of skills than the investor would need for a team investing purely in private equity funds," Yang said. The investor needs to have the capabilities within their team to originate, analyse, and execute direct transactions, he explained.

Typically these are the sovereign wealth funds (SWFs) and the larger public pension investors, he added. Among the top 300 asset owners in Asia in 2017, 78 are SWFs and pension funds, with average assets under management of around $89 billion, according to AsianInvestor's annual AI300 list.

Investors have conflicting opinions on whether direct investments ultimately yield better returns. “There is no conclusive evidence that a direct investment strategy performs better than fund investments when taking into account losses at a portfolio level,” MetLife's Ma told AsianInvestor. She did not provide an estimate of average levels of return from direct investments, however. 

Metlife, she added, prefers PE fund investing, as it tends to be less resource intensive and carries fewer risks.

Another concern for investors is rising PE valuations. “In Asia, large quality assets are scarce, and when you find them, they command a premium. You have to be willing to overpay to buy these assets,” CDPQ’s Brochet said. That is likely to have an impact on eventual returns.

Yet despite all these problems, Asia’s favourable demographics and economies make it too compelling to ignore.

"We clearly need to be in Asia as there are clearly some profitable and compelling themes such as urbanisation and a growing middle class," Brochet added.

*The Asia Private Equity Forum 2018 was organised by the Hong Kong Venture Capital and Private Equity Association.