Investors in Asian private equity funds have a growing problem: their money is sitting around too long and returns are dwindling. The latest mega-vehicle, raised by KKR, is another clear example.

The US firm said on Friday it had raised another $9.3 billion, swelling the $110 billion of so-called dry powder that private equity firms are looking to deploy in the region, according to data provider Preqin. (see graph below).

As the firm looks at ways of putting KKR Asian Fund III – the biggest PE vehicle dedicated to investing into the region – to work, it is turning increasingly to large buyouts in Japan.

Institutional investors, of which there are 175 in the new fund, are increasingly shifting capital into alternative products in the hope of boosting yield. A few, such as Japan’s huge Government Pension Investment Fund, are dipping into private equity for the first time.

The problem is that these investors, also known as limited partners (LPs), have committed to hand private equity funds capital when they ask for it, but the funds are drawing it down increasingly slowly. This dry powder often sits in the coffers of pension funds and insurance companies – waiting for the private equity manager to say he or she needs it.

Jang Dong-Hun, chief investment officer of Korea's Public Officials Benefit Association (Poba), keeps the dry powder he has committed to private equity funds in cash, he told AsianInvestor. As a result, he is looking for managers who can spend his money quickly: “We prefer funds in the final stages of fund raising and especially those with a deal pipeline already in place."

KKR is a big beneficiary of this trend. Cautious managers are attracted to well-known brands that accept very large cheques. They are also courted by KKR’s well-oiled capital-raising machine.  

The New York-based firm is evolving to help put its larger funds in Asia to work faster. It used to focus on minority growth investments in, say, China, but it is shifting to a more mature market with bigger targets.

“What we're seeing more recently is more controlled buyout transactions, especially as I referenced in Japan,” Scott Nuttall, KKR’s Global Head of Capital and Asset Management, in an earnings call with investors.

KKR has already started to deploy Asian Fund III. Its first investment using money from the fund raising was the buyout in Japan of Hitachi Kokusai Electric .

Buyout blues

Private equity’s record level of firepower in the region is pushing up deal valuations. Funds are often going head-to-head with cash-rich corporations seeking to buy growth to meet shareholder expectations.

TPG Capital and MBK Partners beat Hong Kong Broadband Network to buy Hong Kong's Wharf T&T for $1.2 billion, or a hefty 12.2 times the company’s 2015 Ebitda.

Meanwhile, Permira bought Hong Kong's Tricor for $835 million, equating to a steep valuation of about 15 times Ebitda of $55 million in 2015. The UK-based general partner saw off rival bidders Vistra, backed by Baring Private Equity Asia, and Link.

Steep multiples may make it difficult to produce adequate returns, which means that PE firms will have to work harder across every link in the value chain to find attractive companies, increase their worth and sell them at a premium.

  Source: Preqin

“Up to now we think that there has been a premium [for investing in alternatives] – but it is getting smaller,” said Poba's Jung.

Buyout multiples in China have averaged 25.9 times Ebitda versus 9.8 times in Japan between January 2014 and April 2017, according to data provider Mergermarket.

Headwinds

KKR has managed its record-breaking fund raise despite instability in the regional team. In the middle of last year it emerged that the former co-head of Asia, David Liu, was quitting with Julian Wolhardt to start a China-focused investment firm.

At the same time, KKR named Ming Lu sole head of Asia private equity reporting to Joseph Bae, managing partner of KKR Asia. Bae is seen by LPs as a point of stability for the fund, and he remains visibly in charge.

KKR lured 175 LPs into the fund, up from 110 in Asia Fund II. Of these, 53% were headquartered in the Americas, 27% in Europe, the Middle East and Africa, and 19% in Asia. However, Asia punched above its weight in dollar amounts, delivering 24% of the capital raised.

KKR declined to give the names of its LPs, but the Minnesota State Board of Investment has already said it was looking to deploy $150 million into KKR’s Asian Fund III.

In terms of institutions, the majority (61% of the capital) came from public pensions and other government entities.

Benoît Verbrugghe, US head of private investment firm Ardian, said he had made a commitment to Asia Fund III because of the "strong returns on the fund commitments as well as a steady deal flow of co-investment opportunities”.  

The fund's predecessor, KKR Asian Fund II, began investing in late 2013 and is now fully deployed. It has generated a gross IRR of 29.1% and a net IRR of 20.6%.

Asia-focused dry powder

Source: Preqin