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Outlook for Asia PE funds: will deal sizes keep growing?

Author

Author

Paul Christopher

Hong Kong
Managing Partner

13 June 2019

Data from the last 18 months has signalled two clear themes for global private equity (PE) deals: fewer funds closed but, on average, these were larger than in previous years. Paul Christopher considers what this means for the market in the year ahead, specifically in Asia PE funds where the trend is even more pronounced. He predicts that, long-term, there should be a very strong growth story for expert investors in the region.

Introduction

As 2018 drew to a close and the data for global private equity (PE) deals was released, two factors stood out clearly above anything else.

Firstly, the aggregate number of PE funds closed in the year around the globe had fallen compared to previous years. According to year-end numbers from Preqin, the total number of PE funds closed stood at 1,261, down from 1,737 in 2017 (and 1,984 in 2016).

Secondly, while the aggregate PE capital raised globally in 2018 was also lower than the previous two years, there was a considerable increase in the average fund size. A total of US$442.3bn raised in 2018 meant the average fund stood at $350.7m, compared with $327.8m in 2017 (from an aggregate capital raise of $569.5bn).

Put simply, while there were fewer funds closed, those funds, on average, were larger than in previous years. When looking specifically at Asia PE funds, this trend is even more pronounced. The number of funds closed in the region fell significantly from 678 in 2017 to 273 in 2018. Yet the average fund size increased from $217.1m to $299.6m – a huge leap.

Indeed, 2018 saw some of the largest funds ever raised, led by both Asia-based fund managers and global managers raising funds to invest in the region. These included Chinese investment firm Hillhouse Capital's fourth PE fund launch ($10.6bn) – the first Asia fund to exceed $10bn; KKR’s Asia Fund III ($9bn); Carlyle's Asia Partners V PE fund ($6.5bn); and Hong Kong's PAG which closed its third PE fund with $6bn.

So we waited with bated breath to see what the first set of figures for 2019 looked like – would the ‘fewer-but-larger’ trend continue? If the latest data from Preqin is anything to go by, the answer is a resounding ‘yes’.

According to Preqin’s figures for Q1 2019, only 28 funds closed in Asia during the first three months of the year, however the aggregate capital raised stood at $13.9bn. This equals an average fund size of just over $496m –  a further staggering increase.

While admittedly, one quarter doesn’t make a year – the number of funds closed is arguably low because Q1 is typically a quiet quarter in the yearly cycle in Asia – it certainly appears that a pattern continues to emerge. 

Key Trends

As we approach the middle of 2019, it’s worth taking a step back to look at why Asia funds are performing in this way.

Mathematically, having several large funds, such as those above, in the billions in a small pool will have the effect of increasing average sizes.

Strong fund names continue to attract money at the top end, while spin-outs and expert managers with prior experience are also succeeding. It’s also worth remembering that fund sizes don’t tend to be as large in Asia as in the US.

We have, however, identified several Asia-specific trends that we think are worthy of note. Firstly, investors typically chose funds or fund-like structures, particularly Cayman-exempted limited partnerships, as vehicles for joint ventures or for specific corporate transactions. This has resulted in an increased number of quasi closed-ended corporate and project funds, although these transactions would not be taken into account in Preqin's statistics.

This is in addition to the structuring of investor-specific vehicles to facilitate co-investment and separately managed accounts.

While there has undoubtedly been an increase in these trends in recent years, there is now pressure from general partners (GPs) to ensure that investors have the sophistication and ability to follow through on these commitments, as speed-to-execution remains vital.

At a macro level, there is pressure on traditional limited partners (LPs), such as pension funds, to get better returns in a low interest rate environment. So the use of co-investment, in particular, has been an area where this is possible.

A further regional trend has been an increase in distressed situations for investment funds. This includes suspensions of open-ended funds, investors being unable to fulfil capital commitments, dissatisfied investors, and related actions such as seeking GP removal and threatened litigation.

Mourant has, for example, acted in one case of GP removal, an open-ended fund suspension of net asset value (NAV) and a case involving an LP that was unable to pay up its commitment.

Another trend is clients getting to grips with new or updated regulatory requirements in jurisdictions such as the BVI and Cayman Islands. In many cases, this has resulted in an increased focus on deal structures and enquiries to understand compliance requirements. 

There is no doubt that regulation globally is having an impact on transactions. It seems likely that internal compliance teams at the GP may grow as one method of dealing with this, although that is a cost to the GP. Another is to outsource or delegate those functions to specialist service providers.

Headwinds providing a challenge

Against this backdrop, it’s worth examining the headwinds facing the market and how they might affect funds in the Asia region through to the end of 2019 and beyond.

In 2017, two key drivers of Asia PE funds, according to Bain & Company[1], were investors’ increasing confidence in the region and business owners’ greater willingness to accept PE funding. While both of these may still be underpinning the market, Bain & Company's 2018 review noted a very strong year with exit values at all time highs and strong returns, fund raising had declined and large funds with strong track records were dominating activity. There is no doubt that China’s economy is slowing, albeit still growing at a significant rate by global standards.

This is important for fund business in Asia because in 2018, roughly half of the Asia funds raised were China-focused, according to data from Private Equity International. Added to this, US-China trade tensions are a concern for investors – not least because of the latest escalation in May this year.  However, a potentially positive outcome (in due course) from this scenario is that intra-Asia trade out of China may increase or simply alter to adapt to the new rules.

Another possible dampener of deals generally, is the increased regulatory scrutiny of Chinese investors and businesses in their acquisitions – as well as the high-profile divestments being forced on some Chinese businesses – reducing outward trade and acquisitions into, for example, the USA and Germany. As a result, Chinese businesses may instead turn their attention to acquiring assets elsewhere in more friendly jurisdictions, including Asia.

Preqin’s report on its Q1 2019 data flagged the role of Asia – and particularly China – in the venture capital deals sector as being ‘the hot topic of the quarter’, noting that deal value in Greater China declined for the third consecutive quarter. What’s more, the number of VC deals in Greater China fell by 46% compared to Q1 2018.

Outlook for the next 18 months

So, what does this all mean going forward? We believe the fundraising market remains positive for Asia funds, with PE continuing to outperform public markets. While many investors have pared back their GP relationships, smaller funds could attract investors who may fear missing out on future funds, but it seems those GPs with a strong track record should be successful in their fund raising. 

It’s probably worth noting that we aren’t seeing significant discussion of AIFMD in the Asia market, with only the most significant mandates considering the issue. Indeed, should the UK leave the EU – and we will likely have to wait until the end of October to see if that happens – there is an argument for it being less of a discussion topic as the UK is probably the key destination in the EU from which funds are raised.  Although different asset classes do find some countries in the EU of interest.

While there may be headwinds in Asia, with the possibility of even greater headwinds in the global marketplace – such as a downturn in the economic cycle or shorter-term issues such as Brexit (although that could be regarded as an opportunity) – then Asia may be the winner, particularly with the predicted long-term growth in the region.

Factoring in the trends we have seen and the headwinds in place, the question is whether the move towards fewer-but-larger funds in Asia PE will continue through 2019 and into 2020.

In truth, it’s difficult to determine, despite the Q1 2019 figures from Preqin2 indicating that it is doing so in the short-term. Globally, it seems that ‘marquee’ household names continue to attract money as they become more multi-asset and multi-jurisdictional. This indicates bigger average fund sizes, but there is also a trend for specialisation amongst smaller and mid-sized teams too, as well as potential for increasing conflicts of interest within larger teams.

Globally, dry powder continued to climb through 2018, reaching $1.26trn in March 2019 – a new record. It can be difficult to deploy in Asia where deal sizes are traditionally smaller. It will be interesting to see the strategies used to ensure the money is invested – if China is slowing it may mean better deal terms for investors. Asia is a less-developed region generally, so the upside, theoretically, is greater. Having said this, consequently there are greater risks of many kinds.

In conclusion

Over the long term, the increasing middle class in China, an ageing population and the maturing of economics generally in the Asia region mean that there are many positives to point to. In Vietnam, for instance, there is a young population and the market is opening up. Similarly, in Indonesia, there is a sizeable young population. These are but examples of Asian trends which present potential opportunities for investors in the region.

It feels like the market is currently in the balance – there has been a lot of capital raised, but do investors want to see that deployed, and are they still willing to have faith in managers? Long term, there should be a very strong growth story for expert investors in the region.

Find out more about our Asia team here.


[1] Asia-Pacific Private Equity Report 2018 Bain & Company, March 2018

[2] Prequin Quarterly Update: Private Equity & Venture Capital

 

Contact

Paul Christopher

Paul Christopher

Partner | Hong Kong

About Mourant

Mourant is a law firm-led, professional services business with over 60 years' experience in the financial services sector. We advise on the laws of the British Virgin Islands, the Cayman Islands, Guernsey, Jersey and Luxembourg and provide specialist entity management, governance, regulatory and consulting services.

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