New Zealand Superannuation Fund (NZ Super) is preparing to reengage with buyout funds after a decade-long absence. The NZD 79bn (USD 47bn) pension plan has a blank sheet of paper: no distributions-deprived existing portfolio squeezing new commitments; no entrenched geographic or sectoral biases to unwind; just an estimated NZD 1.3bn to put to work over the next 4-5 years.

The portfolio will inevitably skew towards more established markets in North America and Europe, with a likely emphasis on the single-digit fund size space where leverage is less pronounced, according to Doug Bell, a director responsible for investment strategy at NZ Super. But how big a minority share of the allocation can Asia expect to receive?

“It’s hard to make big commitments or spend too much time here. A lot of people have pulled back from China and capital has flowed into places like India and Japan, which seem frothy. We don’t want to be chasing where everyone else is forced to go because they can’t do China. And then China is a difficult nut to crack. Are we comfortable making allocations there today? Not really,” said Bell.

Such deliberations are preliminary. NZ Super isn’t rushing into allocations, so Bell is reluctant to be definitive beyond affirming that Asia-focused managers able to demonstrate meaningful impact – a key issue for the pension plan globally – would be viewed more favorably.

Yet uncertainty on Asia is typical of the broader LP peer group. The Dietrich Foundation is a longstanding investor in China and Edward Grefenstette, the foundation’s president and CIO, regards that market as a potentially strong source of uncorrelated returns for those willing to take the risk. Relatively few, however, seem positively disposed to Asia, let alone China.

“Given the depth and maturity of the US private equity ecosystem, US LPs require a materially higher expected return to invest in Asia PE to reward them for embracing the incremental risks around geopolitical unknowns, currency and regulatory surprises,” Grefenstette explained. “Right now, most are seriously reconsidering whether the juice is worth the squeeze.”

Ones to watch

While pan-regional strategies are not for everyone, they indicate general appetite for Asia, particularly among LPs more inclined to dip in and out. With mandates that span multiple geographies, they also capture that pivot away from China to the likes of India and Japan.

Two managers with large-cap ambitions are now putting their propositions to the test. In recent months, EQT Private Capital Asia [STO:EQT]and Blackstone [NYSE:BX] have unveiled targets of USD 12.5bn and USD 11bn, respectively, for their latest pan-regional funds, while advising LPs they will deploy most if not all the capital outside China. Investors are looking on with interest.

“Next year will be the bellwether for Asian private equity, given the pan-Asian funds in the market and the ones that may follow,” said Liam Coppinger, a senior managing director and head of Asia private equity at Manulife Investment Management. “Their progress will be closely scrutinized.”

EQT and Blackstone can point to prior vintages with China exposure ranging from zero to negligible. The former has deployed over 70% of its USD 11.2bn eighth fund – Fund IX is now in the market – and delivered about the same again in co-investment across India, Japan, and Australia, as well as in cross-border deals that either span the region or connect Asia to US and European markets.

Earlier this year, AVCJ Research sought to track variations in geographical deployment among the major pan-regional players over time. Focusing on transactions for which size was disclosed or reported, including deals where GPs were part of investor groups, it broke down activity into three time periods: 2010-2014, 2015-2019, and 2020-2023.

China accounted for 40% of EQT’s deal volume in the first period and then sank below 5% in the second and third as India and cross-border deals came to the fore. Blackstone, which didn’t have a dedicated Asia fund until 2018, has also seen China dwindle, with Australia, Japan, and India making up 90% of volume in 2020-2023.

TPG’s [NASDAQ:TPG] China exposure dropped off post-2020 to be replaced by Australia and India; CVC Capital Partners [AMS:CVC] was predominantly Southeast Asia through the first two periods before dialing up India and Japan in third; Japan has been Bain Capital’s primary geography by deal volume since 2010; and KKR [NYSE:KKR] has shifted from a relatively even regional balance to two-thirds Japan and India in the third period.

Gaurav Trehan, co-head of Asia Pacific and head of Asia private equity at KKR, observed that Japan now makes up approximately 40% of the firm’s overall regional portfolio.

This tallies with a gravitation towards developed Asia in the large-cap space, defined as deals – buyout and growth – of USD 200m and above. Between 2017 and 2020, Australia, Japan, and South Korea made up one-quarter of investment volume; China was on approximately 50%. For 2021 to date, those shares have nearly reversed. India has held steady at about 15% across both periods.

“When you think about putting out a USD 500m cheque in Asia, it’s Japan followed by Korea, and Japan is a much larger market,” said Michael Kim, a partner and founder of MBK Partners, which was excluded from the pan-regional analysis because it focuses solely on North Asia. “India is increasingly important, but it’s mainly growth capital, a USD 100m cheque here and a USD 200m cheque there.”

Willing to engage?

MBK is prioritizing Japan and South Korea for the present. It hasn’t committed to a new deal in China for three years, but Kim declined to write off the market, citing the size of the opportunity set. Rather, the firm is waiting to see how and when a recovery may take shape.

Multiple LPs report being advised by certain pan-regional GPs that China exposure has been minimal in recent vintages, and it will be unchanged in the coming vintage. “It depends on who they are talking to – some of us get told no China, others are told the door remains open,” one LP added.

Hard commitments to a 10% China cap would constitute the exception, not the rule, even though some in-country teams are being down-sized. Similarly, side letters exempting LPs from any China investments a fund makes might have been requested in extreme cases, but GPs are reluctant to comply. Ultimately, they will retain as much flexibility as negotiations allow.

“It is tricky doing a side letter that says no China. There is a portfolio construction challenge – the performance variation between LPs could be wide – so it would only be offered where managers are under a lot of pressure,” said David Low, a partner at a global LP advisory firm, adding that opt-outs may also upset other investors that end up with more China exposure than expected.

“In real estate, a lot of funds have removed China from their mandate. In private equity, they are saying it is not a core focus and then setting the bar for deals very high.”

Then there is a subset of pan-regional managers that doesn’t necessarily shy away from historically heavy China exposure. Lincoln Pan, a partner and co-head of private equity at PAG, argues that it would be disingenuous to pitch an Asia fund as ex-China, given the firm’s track record there and the fact that its current teams focused on Australia, India, and Japan have been in place for between five and seven years.

“For now, our focus is being a pan-Asian manager that does invest in China. Maybe in two years, the politics will get worse, and we need to re-think our fund setup. But strategically, we are better as one team working cohesively across the region,” he said.

PAG’s fourth fund, which closed earlier this year, is already 40% deployed and includes a couple of China deals. One of them, Newland Commercial Management, is among the largest in Asia to date.

Carlyle [NASDAQ:CG] also remains engaged in China, with X.D. Yang, the firm’s Asia chairman, citing its seasoned team and ability to adapt to local conditions. More buyouts are expected via multinationals divesting local operations, take-privates of Chinese companies listed in Hong Kong and elsewhere, and succession planning situations driven by younger generations not wanting to run family businesses.

In each case, this stated openness to China is encased in a determination not to be defined as China. Pan outlined plans to build a balanced portfolio across PAG’s four core jurisdictions while Yang noted that India is well-established as Carlyle’s largest geography in the region. Indeed, AVCJ Research found that India accounted for 40% of the firm’s deal flow in 2020-2023, double the China share.

Similarly, Warburg Pincus CEO Jeffrey Perlman reaffirmed his commitment to China, outlining three perquisites for deals in the country in the new paradigm: control, or very meaningful governance rights; alignment with government policy; and being able to exit to domestic buyers. Yet the firm is also responding to investor demand for diversity by expanding coverage to include developed Asia.

Competitive edges

Taken more broadly, this shift in regional emphasis raises three questions: Are the target markets, notably Japan and India, deep enough to absorb additional capital at the large end of the spectrum? Do managers have the track record, local resources or competitive edge to suggest they can execute consistently in these markets? And are fund sizes still appropriate for the opportunity set?

It doesn’t help that deal flow in the USD 200m-plus segment has been slow region-wide. The reawakening in private equity activity globally has yet to encompass Asia, where USD 91.8bn has been deployed year-to-date. From the 2021 peak of USD 267bn, investment slipped to USD 139.5bn and USD 109.6bn in 2022 and 2023. In short, Asia is operating at 2015-2016 levels.

Australia’s running total for the year is almost double the 2023 tally, but the bumper sale of data center operator Airtrunk is three-quarters of that. India and Japan are not even halfway towards replicating 2023. Slowness is blamed on a wide bid-ask spread, although Peter Graf, head of sponsor direct lending for Asia at Ares Management [NYSE:ARES], believes the debate has become more nuanced.

“If you’d asked me 12 months ago, I would have said bid-ask spread almost exclusively. Now, some of the sky-high valuations have gone. While the bid-ask spread is still a consideration, sponsors are also looking at the equity thesis, asking where they can find growth in the underlying asset, what kind of competition they face, and whether they are the right pool of capital to be doing it,” he said.

“There is still competition for the best assets. For those in the middle, it’s patchier because buyers can’t get the thesis to stand up.”

Market-specific observations shared by industry participants are familiar: Australia’s relatively shallow pool of large-cap assets circulating through processes, or take-private bids, as sellers wait on a public markets upswing; India’s already buoyant public markets pushing up asking prices; and Japanese sellers seeking a premium for exposure to appealing yet hard-to-access deal flow.

At the same time, compelling arguments are made for more large-cap opportunities emerging in Japan and India, whether driven by corporate governance reforms and policy agendas in the former or rapid economic growth and a gradual swing from minority to control in the latter.

Stephanie Hui, head of Asian private equity and global co-head of growth equity at Goldman Sachs Asset Management, highlighted the scope for more take-privates in Japan. The economy is one-sixth the size of the US, but both have 4,000 listed companies, the Japanese total doubling over the past 15 years while the US total has halved. The need for rationalization is clear.

“Larger funds that haven’t allocated as much to China in the past two to three years have increased exposure to India, Japan, and Australia,” added Hui, who operates in Asia’s upper middle market space. “As a result, some of the large buyouts – especially in India – are highly competitive. But India is a liquid market, growth is solid, so it should be able to take on more growth and buyout dollars.”

The pan-regional and global calling card remains combining local resources with global expertise. EQT, Blackstone, and Carlyle used this to great effect in IT services, providing capital and best practices as companies built out their back-end operations in India while simultaneously facilitating expansion on the US-facing front end through marketing upgrades and client introductions.

Investors claim to see similar opportunities across the region, from the India-US channel to bolt-on acquisitions that bridge Japanese and Korean industrial players into Western markets to brand and distribution expansions within the Asian region and beyond. It includes China nexus deals, where accessing customers and suppliers in China is transformational for a foreign company.

Pattern recognition across markets comes into it as well. KKR, for example, is leveraging healthcare experience accumulated in more advanced geographies as the opportunity set broadens in emerging Asia.

“As Asia’s contribution to global healthcare spend continues to rise, we are seeing attractive healthcare opportunities in emerging markets such as Vietnam and India, where we have acquired hospital chains, medical devices makers, and healthcare solutions providers,” said Trehan.

Carlyle’s Yang emphasized the value creation element, including a willingness to change management rather than passively back incumbents. “There’s hardly a deal that comes to our investment committee today without an M&A story. And then the first questions asked in discussion invariably include, ‘Do we stick with the CEO?’, ‘Do we change the CEO?’, and ‘Who are the potential new CEO candidates?'” he said.

While operating talent and global connectivity are commonly espoused virtues, LPs must assess an individual firm’s ability to apply them in markets where talent is short and deal-sourcing processes can be long. Ask how a manager can justify a USD 10bn Asia fund with a minimal China allocation and there will be half a dozen different responses, some more credible than others.

“Some that have been more China-focused and are newer to some of these other markets will have a tough time convincing LPs they should back them as part of their expansion. Those with established footprints will out-fundraise those who are developing their footprints,” said Nick Milnes, a director who covers Asia and Europe private equity at MetLife Investment Management.

Follow the money

MetLife’s Asia portfolio is split equally between pan-regional and country funds by assets, and there is a bias towards developed markets. Milnes sees no reason to change this, noting that markets such as Australia and Japan have delivered strong returns because the full range of exit options is available. India is more limited, which undermines confidence in its ability to perform consistently.

Manulife plans to maintain its pan-regional exposure in terms of number of relationships, while re-upping with mid-cap managers in markets like Australia, India, and Japan. Any additions are likely to come in the mid-cap to lower mid-cap space, especially in Japan, though Coppinger acknowledged that writing cheques for sub-USD 500m funds is hard work and seldom delivers co-investment.

NZ Super has yet to launch this debate in an Asian context, but it is already happening in Europe. Bell said the pension plan is leaning towards pan-regional because it favors diversification and “doesn’t want to be too cute in picking countries or sectors.” A European pension fund LP, whose Asia budget is about to be cut in half, added that a sliver of pan-regional buyout is all that will remain.

Even though large-cap strategies will be a mainstay of Asian exposure for many investors, the bifurcation effect described by Milnes is endorsed by other industry participants. EQT and Blackstone are being watched carefully because the extent of their success – no other manager has surpassed USD 10bn in this cycle – may appear to confirm it.

“Before, there was the promise of China. Now there’s the promise of India, but it’s a much smaller market. Take China out of the equation and returns have been okay in the pan-regional space, but they still trail the US and Europe,” said Doug Coulter, a partner at LGT Capital Partners. “We are seeing the great re-setting of fund sizes in Asia Pacific. It’s long overdue. LPs are happy about it, and GPs need to get used to it.”

PAG could be viewed as an early indicator of this trend, with Fund IV coming in at less than two-thirds the size of Fund III. The experiences of its peer group have been mixed – some finished above target and others below. A quirk of the current cycle is the material change in global conditions in early 2022; those launching funds before this were arguably more aggressive in their ambitions.

However, a rationalization in large-cap fund size doesn’t necessarily signal a retreat by those global and pan-regional managers. They will simply find other ways to boost assets under management.

“If your brand is successful and your flagship fund has reached a stage where it can’t grow anymore or there is minimal growth per fund, you leverage your brand to launch other products,” said Michael Liu, a managing director at Portfolio Advisors. “It has already started to happen.”