Spiralling stock valuations of technology companies could have a damaging effect on private equity rewards, so family offices and other investors should consider looking to out-of-favour sectors such as financial companies that could act as a good inflation hedge, suggests the chief investment officer of Nan Fung Trinity, a Hong Kong family office.

While global equities were hit by volatility as the coronavirus pandemic raged across the globe last year, Asian investors poured money into private markets, especially private equity, as well as a range of initial public offerings, noted speakers during a panel at Asian Financial Forum’s family office symposium on Tuesday (January 19).

Paul Uren
JP Morgan

“Last year in Asia private capital volumes were around a $115 billion versus IPOs, which were around $84 billion last year – and it was a very strong IPO market throughout Asia,” said Paul Uren, JP Morgan’s Asia Pacific head of investment banking coverage.

Popular sectors for IPOs and private equity investments last year include alternative energy, electric vehicles (EVs), medical technology and education technology, the panellists said. 

However, the valuations of popular tech firms have soared to such a high altitude that private equity investors are finding it increasingly hard to compete, said Helen Zhu, CIO of Nan Fung Trinity. 

Helen Zhu
Nan Fung Trinity

“Entrepreneurs’ valuation expectations have caught up a lot [to where tech companies’ stocks are valued today],” Zhu said. “It’s much harder for some of the private equity guys or venture capitalist guys to put money in at this level… The ask valuations are substantially higher than what they were pre-Covid.”

“If you look at the S&P 500, it delivered approximately [annual] returns in the low 20s. If you were to strip out the six largest tech giants that return would go down to 6%. So, really, [tech] growth is the next big thing,” added Kosmas Kalliarekos, managing director of Baring Private Equity Asia.

LOOKING ELSEWHERE

These higher valuations mean general partners must pay more to gain stakes in appealing tech companies. That could potentially crimp future fund returns.

“As the global economy continues to improve, interest rates will go up because of a cyclical recovery and synchronised recovery in the global economy… [So] we can't really count on valuations to continuously expand endlessly the way that they have done for the last decade,” Zhu said.

This could prove a problem for family offices, given their strong predeliction for private equity. 

The UBS 2020 Global Family Office report noted 69% of family offices view private equity as a key driver of returns, while Credit Suisse's Capital Market Assumptions five-year outlook report in November 2020 forecasts private equity to have a 9% to 10% return over the next five years.

 

In addition to private equity options, family offices and other investors have begun to increasingly focus on tech firms' private funding efforts. Both Zhu and Uren observed that crossover investors, or those shifting from public to private market investments, have been showing up “relatively late, but pre-IPO”.

“More of the activity is really at the later stage where [investors] feel like the company's mature enough and dominant enough and there is a visible timeline to IPO,” Zhu said, adding that it often happens when the companies are about six to 12 months away from IPO.

However, valuations are also surging in the private space. The highest-valued pre-IPO start-ups in the world are in China, according to Statista. These include Bytedance, the tech giant behind popular mobile video platform Tiktok, which is valued at $140 billion, while ridesharing company Didi Chuxing enjoys a value of $62 billion and counts investors such as Temasek Holdings, China Investment Corporation and Ping An Group.

Kosmas Kalliarekos
Baring Private Equity Asia

With valuations of tech companies becoming so hot, Zhu said Nan Fung Trinity has begun “looking forward and diversifying a little bit more beyond what was the hottest areas of the last three to five years.

“During the next decade, we need to be open-minded to all sorts of opportunities and be very strategic particularly for the more illiquid [assets].”

Zhu clarified that she is looking at undervalued sectors including financials and insurance, in answer to a question posed by AsianInvestor.

“With the collapse in interest rates to historical low levels, [the financials] area was completely trounced in the public markets and we saw unprecedentedly low valuations,” she said.

“Similarly, insurance is probably an area that's worth getting a little bit of exposure to, largely because inflation expectation is just so low… In the next six to 24 months people are going to be surprised by how fast inflation starts to come back.”