Global investors have always recognised Asia as a diverse and complex opportunity, but the view has been somewhat simplified by an imbalance in exposure. As an historically China-dominated approach to the region embraces a broader mix of markets, the traditional shorthand that frames Asia as a generally high-risk, high-reward destination will become increasingly obsolete.

Asia will continue to be conceptualised by many as a sprawling yet contiguous geography – from annual reports that reduce it to one statistical block to job titles that bind together multiple markets. To the extent this includes investment allocation decisions as well, it may contribute to continued disappointment in returns versus major Western markets.

Investors can respond by retreating from the region or taking a closer look at how they execute fundraising and capital deployment strategies across the hemisphere. For those in the latter camp, the effort will involve building out capacity to play against the shifting strengths of subregions.

Meanwhile, the macroeconomic and geopolitical drivers prompting investors to diversify their exposure and redefine the region’s risk profile are simultaneously amplifying the challenges of doing so. In this light, Asia’s fragmentation plays the role of both diversification advantage and unpredictability aggravator.

“The notion of Asia private equity as an asset class has been somewhat disproven. It’s consistently underperformed the US and Europe. It’s got higher volatility. Drivers of returns are different in each market, and no fund has a perfect setup that covers the whole thing,” said Matthew Michelini, head of Asia Pacific at Apollo Global Management [NYSE:APO].

“There’s great manager selection in different countries, but by and large, you’re taking more risk, and you’ve seen that in returns. So, investors are now thinking more deeply about how it fits in their portfolios.”

The context for this rethink is a contorting landscape. The prevailing view is that Asian private equity has been largely sustained by big money from North America since the early 2000s. As those inflows contract as part of a global slowdown, the region will experience relatively greater strain.

Harder to calculate is the offsetting effect of a gradual influx of regional primary capital into the industry and the extent to which these investors – including family offices and new sovereign entities – stick to their home markets during periods perceived to be riskier.

Globally, private fundraising fell 15% in 2022 and 2023, according to McKinsey & Company. Commitments to Asia ex-China funds rose 8% and then declined 30%, AVCJ Research found, while a 14% drop for US dollar-denominated China funds in 2022 was followed by a 53% drop in 2023.

Reassessed priorities

Michael Langham, an emerging markets economist at Abrdn [LON:ABDN], sees logic in the China pullback amidst real risks in domestic regulatory uncertainty and geopolitical tensions but believes investors have become too bearish on the country and Asia overall.

He paints a region where, more than other developing markets globally, policymakers have tended to make the right calls in terms of maintaining current account balances post-pandemic and adapting to changes brought about by trade wars. The redistribution of investment flows has allowed many countries to rebuild their reserves and improve their risk-reward profile.

Abrdn estimates that Asia’s share of global growth, currently 35%, will hit 46% by 2050. Ongoing pivots from investment-intensive to consumption-led growth in China and India are the key drivers. Between 2020 and 2050, consumption will triple in China and quadruple in India, reaching USD 25trn and USD 7.4trn, respectively. Over the same period, US consumption will grow 50% to USD 22.8trn.

“The challenge is that the Federal Reserve doesn’t cut rates much further or has to keep them higher for longer. That would continue the theme of Asia needing to provide even higher returns to attract foreign investment,” Langham said.

“If you have a US risk-free rate of 5%, you’ve got to rethink as a region how you attract foreign investment. That’s a challenge, but it’s not something that can’t be tackled.”

The risk factors around the pullback from China are not seen as short-term phenomena. The natural deceleration of the economy and the political strains on the exit environment make it almost impossible to forecast the country returning to its former level of dominance, where it typically represented more than 50% of Asia exposure for global investors.

There is also little expectation that any other market will fill the void either. Asked whether India could experience a similar imbalance in investment attention amidst a wave of strongly positive sentiment, Caitlin Gubbels, global head of private equity at Canada Pension Plan Investment Board (CPPIB), noted that it did not provide the required scale.

“We are focused on pursuing attractive relative value across the region without explicit deployment caps or targets in any specific country,” she said. “Through diversification and maintaining a disciplined outlook, we can better manage risks and seize opportunities within the evolving Asian markets.”

Ontario Teachers’ Pension Plan (OTPP) has moved aggressively on India in recent years, but likewise espouses a diversified approach in the current environment. Cindy Yan, a senior managing director for direct investing and private capital at OTPP, pointed to a deeper integration into global trade versus five years ago and the diversification of national economies as attractions of emerging Asia.

“Investors are likely to view the region as less risky compared to the past, which could lead to increased investment flows,” Yan said.

“We’ve always moved away from a one-size-fits-all approach, and it’s encouraging to see investors recognising Asia as a set of unique growth paths depending on the country. This maturing environment will continue to allow for more steady, long-term investment strategies.”

Diversification, not growth

There is widespread confidence that growth will continue to outpace inflation. As consumerism in these geographies swells, an increase in intra-Asia trade is expected to insulate the region from fluctuating demand from the US and Europe. Yet there remains a sense that the numbers aren’t adding up.

One senior executive responsible for private markets at an Australia superannuation fund observed that while the pullback of global capital in emerging Asia is no more severe than in other higher-risk areas such as tech, the outlook for a rebound in sentiment is weaker.

“Even in the instances where we have committed to developing markets in the last five years, they’ll have the currency risk stripped out or they’ll be some other security,” the executive said. “The experience for most investors is that for all the risk and complexity that you’re taking on Asia, in aggregate, it hasn’t actually rewarded you more than staying home.”

The key argument for Asia in spite of this disappointment is that it has become more appropriate to think of the region as a diversification play than as a growth play.

Collwyn Tan, co-head of Asia investment at Hamilton Lane [NASDAQ:HLNE],, makes this point by describing the pullback as a mostly private markets phenomenon despite private markets in the region being more competitive than public markets relative to their Western counterparts.

The logic for global investors maintaining their public markets presence in Asia is supported by the liquidity of the asset class. Although Asian exchanges are relatively light on high-growth sectors such as software and have not performed as strongly as those in the US, the exposures are easily moderated, supporting the case for low-commitment albeit low-upside geographic diversification.

That global demand for geographic diversification without necessarily expecting far superior outcomes appears to be coming to Asian private equity.

Tan noted Hamilton Lane has fielded an increase in inbound inquiries from global LPs in the past two years about how to pursue investment in Asian private markets. This includes LPs with no such existing or historical exposure, who are often enticed by a correction in Asia valuations.

They see a landscape transitioning from a growth equity-oriented opportunity to a stronger focus on buyouts. Part of the attraction here is the idea that Asian control deals are to some extent de-risked by being generally less levered than buyouts in more mature markets.

GPs are deploying more thoughtfully with historically slow pacing, suggesting the deals they do close are high-conviction bets that will benefit from more supporting resources. On this basis, Hamilton Lane believes the current vintages could perform strongly, potentially defining the beginning of a new cycle of confidence and deployment in the region.

“We think this is a chance that private markets become the go-to assets in Asia because there are a lot more options in terms of strategy and geography to get exposure to good companies,” Tan said. “It may get to the point where people will just access private equity in Asia as a way to tap into growth because the public equity performance has been mediocre to say the least.”

Taking control

Fund managers repackaging Asia as a broader, less China-focused and more mature, slower-growth offering will be under increased pressure to demonstrate a capacity to penetrate multiple subregions and execute value creation.

Warburg Pincus sees the current environment as an opportunity to lean into Asia, including developed markets such as Japan, not because the macro backdrop is particularly inviting but because the deal-level competitive dynamics have improved markedly.

“I don’t think investors that have a history of allocating toward Asia are pulling out. But they want a model where you’re not just investing in the best deal in China or the best deal in India – you’re investing in the best deal in Asia,” said Vishal Mahadevia, head of Asia private equity at the firm.

“If you have a diversified portfolio in Asia, you should be making returns that are at least commensurate with the US, with a shot to do better, which is what people come here for.”

Ten years ago, less than half the capital Warburg Pincus put to work in emerging Asia went to control deals; now it’s the majority. Six out of its last eight investments were buyouts. So were its last three in Southeast Asia.

The deal flow has featured mix of generational transition opportunities, platform acquisitions, conglomerate sales of non-core assets, and an uptick in sponsor-to-sponsor deals provided by domestic growth-stage and VC players.

Regionwide, buyouts represented 48% of private equity and venture deal flow in 2023, versus an average of 32% during the five prior years, according to AVCJ Research. This development has been associated with greater control over exits, a greater variety of exit channels, and therefore a potential turning point for investor perceptions.

“A lot of these growth markets were reliant on IPOs for exits in the past, but that’s rapidly changing. The segmentation of private equity in Asia from small to mega has created an opportunity for transformational buyouts,” said Brian Lim, head of the Asia and emerging markets investment teams at Pantheon.

“That de-risks things in a very significant way. We’re not just subject to whether the IPO markets are open or shut. People need to bear that in mind.”

Back and forth

The evolution of Bain Capital’s Asia exposure helps illustrate how perceptions of risk have shifted around the region. Fund I, which closed in 2007, focused on China and Japan. In subsequent vintages, Japan has remained the anchor while India exposure gradually increased and China exposure decreased.

Jonathan Zhu, Bain’s co-head of Asia private equity, highlighted the breadth of the India opportunity, which stretches from manufacturing – pending some infrastructure development – to consumer.

“In China, there was a period when the consumer internet market was an extremely powerful engine, and a made a lot of money doing that. There isn’t a sector like that in India,” Zhu said.

“We can talk about IT outsourcing as a theme, but it’s smaller. AI [artificial intelligence] could be a tailwind for that sector, making it more efficient, but it makes things complicated and you have to change your model. There’s hope in India, and I believe it will play out, but the timing is uncertain.”

Zhu does not rule out the idea that India could eventually play a China-style role as a backbone Asian market for global investors. But this would need to be driven by the consumer sector, which likely requires another 10-20 years of market evolution to become a dominant source of growth.

In the meantime, the broader industry appears to be grappling with an instinct that Asia cannot carry on as an anchorless region.

At the Milken Institute Asia Summit in Singapore in September, investors and economists, convened for a panel called, “Is China the Next China?” Although there is almost no expectation of China reclaiming half the region’s investment dollars, the question is taken as a sign that sentiment is beginning to thaw.

Some investors are beginning to sense an improved margin of error in China commitments related to reduced valuations, domestically sustainable profits, and competitive technological domains. Hamilton Lane, for example, opened a Shanghai office last year to pursue emerging deal flow in underpenetrated areas such as renminbi-denominated secondaries.

“This is the first time in my investment career where I can see a Chinese company growing at double-digit growth, making double-digit EBITDA margins and being transacted at single-digit EBITDA multiples,” said Tan of Hamilton Lane, who has been investing in Asia for 15 years.

“The ball is really in the GPs’ court. The challenge right now is for GPs to regain that confidence and choose the pockets where they can articulate a story to LPs. The real trick of the trade is to look at Asia as various pockets and not group them into sections because it takes different strategies and approaches to make handsome returns in each market.”

Black swans?

Geopolitics overhangs everything on the subject of Asia risk, but as impossible as it is to ignore, it is equally impossible to quantify and accurately underwrite.

Part of the challenge is that geopolitics is increasingly being experienced as a borderless disruptor. Even in seemingly uninvolved jurisdictions, tensions can flare, supply chains can be interrupted, and the universe of potential counterparties can contract.

Speaking at the AVCJ Private Equity Forum Singapore 2024 in April, Sandeep Naik, head of India and Southeast Asia at General Atlantic, illustrated the futility of trying to box out geopolitical risk from an investment mandate.

In one situation, an Israeli strategic investor was completing due diligence on a Southeast Asia-based portfolio company, with a final bid expected within a fortnight, when the Israel-Gaza war broke out. It was compelled to pull out. Another exit process was delayed when the Indonesia franchisee of a large US consumer brand was put on a boycott list in protest at the Israel-Gaza conflict.

Naik did not name the latter company, although it has been separately reported as Starbucks [NASDAQ:SBUX] operator Map Boga Adiperkasa. CVC Capital Partners [AMS:CVC] was said to have simultaneously suspended the sale of fast food operator QSR Brands in Malaysia due to similar boycotts.

“Could I have ever thought that this is a risk that could play out before I made the investment? No, but these kinds of geopolitical risks are now playing into your investment thesis and your returns,” Naik said.

Most of the investors contacted for this article consider such episodes as outlier scenarios and indeed evidence that geopolitical risk is not a greater challenge for Asian than any other region.

Yet there is a school of thought that Asia’s physical distance from Western markets can amplify concerns about geopolitics. A calamity in a familiar regional market – such as the war in Ukraine for European investors – feels more manageable than the spectre of a potential war on the opposite side of the globe.

Part of the solution is to ensure that teams are local and therefore not unnecessarily spooked by geopolitical stresses that appear more volatile from afar. But even then, investors must understand that in some worst-case scenarios, businesses will down go to zero.

Even in the relative safe haven of Japan, Bain considers the country’s vulnerabilities in terms of its reliance on open sea lanes, pricing the possibility of a regional war into deals. “We underwrite to higher returns in Asia than we do in the US in part because of the risk that we see,” Zhu said.

In some of its equity and credit deals, Apollo prices the insurance of geopolitical risk to test if the planned return is viable. It’s an imperfect system, but it at least provides some third-party perspective. In many cases in Asia, the price is too high.

“It’s no longer acceptable versus five to 10 years ago, to dismiss war as a low-probability event. Now the probability has to be factored into your thinking,” Apollo’s Michelini said.

“If you’re depending on a lot of trade and business finance through the South China Sea, you have to really think hard about what different scenarios could mean and how that impacts your business. You have to factor those scenarios into the deal cost.”