Looking at the numbers, it’s apparent that Asia’s private equity star is shining bright. Assets under management increased ninefold during the last 15 years to about $283 billion in 2009 – 60 per cent of that growth came in the last five years alone.

But for all its healthy growth, only one third of global limited partnerships (LP) have allocations to Asia, including developed markets like Japan, South Korea and Australia and developing economies like China and India, according to Preqin (a research firm focusing on alternative investments). Also, the region’s assets under management have maintained a fairly steady percentage of around 10 per cent of the global private equity industry’s assets.

“This may surprise market participants since absolute numbers, particularly in context with Asian economic forecasts, always point to much stronger growth of Asian PE relative to the rest of the world,” says Claudia Zeisberger, Academic Co-Director of INSEAD’s Global Private Equity Initiative.

Asian private equity’s long-term returns have not been exceptional; while on par with returns in the United States, they are quite a bit behind Western Europe. Ten-year net returns for Asia stand at 7.3 per cent, with three-year and one-year returns showing more strength at 9.6 per cent and 37 per cent respectively. Yet these short term returns have to be discounted as little meaningful in this asset class.

So what does this mean for private equity investors seriously contending with Asia? “The single most critical driver since the financial crisis, are the exit opportunities and the successful exits undertaken over the last two to three years in Asia, particularly with regards to China” said Zeisberger in an interview with INSEAD Knowledge. “Now driving the force behind the acceleration is clearly the mainstream opinion that emerging markets is the place to be.”

Zeisberger combines her comparative analysis of global private equity with a recent survey conducted jointly by INSEAD GPEI and Axa Private Equity between March and June of 30 institutional limited partners and 50 general partners (GPs) operating in Asia based on their experience, brand and peer recommendations. Survey findings revealed factors for both optimism and concern. “The positive direction of Asia’s development is definitely undisputed,” says Zeisberger. “What causes concern is clearly the pricing side. I would argue that markets currently price expected economic growth, not risk as they should.”

Risk concerns in developing Asia

Yet LPs still expect a fairly high risk premium for developing Asia, which includes the emerging economies of China and India, compared with western private equity, the survey shows. While there was little, if any, risk premium in developed Asia (Japan, Korea, Australia), LPs investing in developing Asia expected a risk premium that averaged about 6.5 percent higher for their investments. “It is not a risk-free strategy,” explains Zeisberger, largely because evaluating and pricing investments in an emerging market environment is not easy.

“Benchmarks are at times impossible to obtain, valuations are very often driven by the entrepreneur on the venture capital side or by the company itself, not necessarily by the GPs themselves.” As a consequence, investors often find it very difficult to find appropriate private equity firms that align with due diligence standards adhered to in Western Europe and or in the US.

Another related risk factor applies to the variability in GP returns. The variance of fund returns in Asia during the eight years to 2005 has been significantly higher at 23 per cent compared with Western Europe and US variance between 13 and 15 per cent. It is, however, useful to note that the top quartile of Asian GPs outperformed their Western counterparts in absolute returns since 2003. “Clearly, a lot comes down to manager-selection skills,” says Zeisberger. “Yet the nature of the industry makes this selection a daunting task.”

Portfolio allocation plans and strategies

To this end, the survey uncovers alarming levels of dissatisfaction among LPs with their existing GPs. On average, LPs said they would not renew nearly a third of their existing relationships citing poor returns, operational issues - often including the departure of key people - and strategy drift. Going forward, they plan to evaluate and recalibrate their current relationships.

This poses somewhat of a conundrum as most LPs indicated their plans to increase their allocation to Asia in the next 12 to 24 months. Some 90 per cent of LPs surveyed planned to increase allocations to China, and 70 per cent to India, shifting from the developed markets in Japan and South Korea. Nearly three-quarters of the LPs said they planned to increase allocations to growth strategies, only maintaining their ongoing levels to buyouts.

Differing outlook for LPs and GPs

Interestingly, LPs and GPs differ perceptibly in their outlook for private equity in Asia. When asked about expected growth rates of private equity assets under management, two thirds of LPs expected growth rates to be above the five-year average of 20 per cent, more optimistic than the GPs who see growth rates remaining at historic levels. As for returns, the GPs expect higher mid-term gains than what have been already achieved, while the LPs expect that returns will probably be the same, if not worse, than in the last five years. “With returns, LPs seem to be less ambitious, which is good news for the new GPs to the region,” says Zeisberger.

Private equity comes of age in Asia

Private equity today appears to be the ‘flavour of the month’, she says, and LPs expect to expand their allocations to Asia strongly, considering that only 32 per cent of LPs globally have done so already. Yet many GPs don’t come with appropriate track records, making it a challenge for LPs to choose a well-diversified, moderate risk portfolio of private equity exposure to Asia.

So what advice can Zeisberger offer newcomer and existing investors? “Stay with the GPs that you might already have a relationship with, ensure that you do your due diligence (regardless) of how difficult it is to do. It might be that LPs have to build up local teams on the ground that can bring in the information that just cannot be obtained through a remote due diligence processes.”

 

A comprehensive report, Asian Private Equity: Will it Deliver on its Promise?, based on the survey findings is available here.