With fundraising at a 10-year low and investors flocking to more proven markets, Asian private equity firms must tell their story more effectively and think about how they provide solutions to LPs

Private equity globally has become a tougher sell. Slower distributions mean reduced LP budgets – less capital is available for redeployment – and in some cases, this is exacerbating overallocation relative to other asset classes. On top of that, elevated interest rates are challenging the risk-return dynamic: What must PE deliver to justify its place in a portfolio when 5% can be earned on cash deposits?

Yet Sarah Farrell, head of private equity for Europe and Asia at US-based Allstate Investments, believes the coming vintages will be among the best. “Interest rates are up, but investing now, the pricing is much better than in 2021 when you would pay 20x for a racehorse and hope you didn’t get a donkey,” Farrell told the AVCJ Private Equity & Venture Forum.

She described 2023 as “the best year I’ve had in a long time,” as the balance of power tipped back in favour of LPs. Co-investment volumes were down, but Allstate had the pick of some high-quality assets. New GP relationships are entered into cautiously, but the firm added four names to its portfolio, including sector specialists in financial services and healthcare. All these managers are based in Europe.

“The macro in Europe is not attractive, but I don’t view private equity as a macro game. Everything I do must have the same ability to chin the bar of our return target from a risk-adjusted basis as anything my US colleagues present,” Farrell observed.

Nearly 12% of Allstate’s USD 60bn in assets are in private equity, with Europe and Asia accounting for about one-third of the deployment target. North American supremacy is driven by liabilities – Allstate, the firm’s insurer parent, primarily operates in US dollars – and historical returns. Allstate is not alone among LPs in favouring the US, and in a climate of reduced allocations globally, Asia is feeling the sting.

Commitments to funds focused on the region, excluding renminbi-denominated vehicles, came to USD 55.5bn last year, about half the 2022 level. It is the lowest annual total in 10 years, according to AVCJ Research. With greater emphasis placed on a GP’s ability to demonstrate differentiation and maintain alignment of interest with LPs, the investor relations function has arguably never been more important.

“We shouldn’t forget – and maybe the last few years of plenty have made us forget – that we are in the relationship and client service business,” Alexis Maskell, a partner and global head of IR at Europe-based BC Partners, which has raised over EUR 30bn (USD 32.8bn) across 11 PE funds, told the forum.

“We need to engage on a regular basis, stay close to our investors, and remain current. That’s the only way to build relationships and to find solutions that satisfy client needs. And those needs are changing.”

Paradigm shift

From an LP perspective, one of the biggest challenges is underwriting commitments when the economic conditions managers will face over the next 10 years are likely to be markedly different from the last 10 years. Cheap debt financing, ample liquidity, rising valuations, and tailwinds in areas like technology and healthcare: these driving factors have weakened and, in some cases, reversed.

Private equity firms across the size spectrum now routinely make the case for value creation, underlining the extent to which their historical returns derive from improving absolute EBITDA rather than riding on a wave of valuation expansion captured in increasing multiples of EBITDA.

LPs are not dismissing track records as imperfect indications of likely future performance, but they recognise the need to dig deeper into what – and who – contributed to returns. For Asia Alternatives, operator of the region’s largest dedicated fund-of-funds, it is about identifying patterns in past behaviour, linking them to circumstances at the time, and asking whether these can be carried forward.

“Every cycle – sometimes it’s global factors, sometimes it’s local factors – markets are constantly shifting. GPs must adapt constantly and reinvest in themselves. What worked in the past may not work in the future or may not work the same way in the future,” said Rebecca Xu, a co-founder and managing director at Asia Alternatives.

“We are looking for managers that have not only created success in the past but also can learn and grow based on lessons from the past. That includes whether they can preserve talent within the organisation and continue to develop younger generations. It’s a very dynamic assessment process.”

Talent retention is a longstanding challenge in Asian private equity, with Wataru Kano, an executive director and head of Asia investments at Japan Post Bank, citing team volatility as a reason not to take track records at face value. Japan Post Bank routinely conducts deal attribution analysis, runs reference checks, and asks GPs to tell the story behind specific investments.

There are some obvious red flags, perhaps best exemplified by a recent trend that has seen Chinese managers try to reposition and target sectors that are favoured by Beijing or geographies that are beyond Beijing’s reach. Geoff Lee, an executive director and head of private markets at Malaysia’s Khazanah Nasional, told the forum that any pivot must come with a compelling supporting argument.

“You say, ‘Let’s do semiconductor in China because it’s the hot thing and the government is supporting it.’ But have you done semiconductors before in China? Is it the same team? Do you have the experience?” Lee noted. “Or it’s ‘China isn’t interesting, let’s invest in Southeast Asia.’ How long have you been in Southeast Asia? Have you paid tuition fees? Have you lost money? What have you learned from it?”

Lines of dialogue

This imperative to take a longer look at managers has reinforced what many in the industry already knew: reaching out to LPs a matter of months before a fundraise with a view to converting relationships into commitments is usually a fruitless exercise.

India-based ChrysCapital Partners closed its ninth fund in late 2022 on USD 1.4bn, although the fundraising process was largely concluded at least six months earlier. The GP will return to market with Fund X this year. Saurabh Chatterjee, a director responsible for IR, said he takes a two-week break post-final close and is then back on the road, meeting new LPs and providing updates to existing backers.

“LPs are happy when we meet for the first time and I tell them that we just closed our previous fund, so we aren’t fundraising for 18 months. There is a sigh of relief, and they say, ‘Okay, we can take this seriously, we can move forward,’” Chatterjee explained. “LPs want to understand, to build comfort with the platform, the team, and the strategy, and to make sure you are doing what you said you would do.”

For ChrysCapital, the journey from first meeting to fund commitment is at least 12 months in length. While LPs want to evaluate the team and strategy, this time is also spent understanding the India opportunity. That said, India is not the only market characterised by extended courtships, and some managers welcome the opportunity to have more substantive discussions with investors.

When Australia-based Next Capital closed its fifth fund on AUD 375m (USD 251m) in mid-2023, the new LPs included one institution that had been in talks with the firm for 20 years. According to John White, a partner at Next Capital, private equity firms that can outline their strategy and then go back to LPs and demonstrate the implementation, have more credibility when it comes to asking for money.

“It’s being transparent about strategies and why they were employed, including when they didn’t work. It’s important to be able to enunciate why it didn’t work, why you would do it differently next time, and what we are going to do to fix problems that might be occurring,” he told the forum. “That only happens with regular dialogue. You can’t have those discussions once every three years.”

Large-cap players are not immune to the downturn in Asia private equity fundraising. AVCJ Research has records of only four closes of USD 2bn or more, with Bain Capital accounting for 41% of the USD 17.4bn raised. In 2022, 18 funds crossed the USD 2bn threshold, collecting USD 55.2bn.

With a handful of large pan-regional players experiencing protracted fundraises, country managers saw increased momentum despite the challenges in China. Between 2018 and 2022, pan-regional funds received 40% of capital committed to the region on an annual average basis. Pan-regional funds of USD 2bn and above took 25%. In 2023, these shares fell to 31% and 18%, respectively.

Nevertheless, country-focused GPs are looking to their global peers for guidance when it comes to building out IR competencies. At Next Capital, the partners lead fundraising efforts, but White recognises the merits of the “systematic” approach employed by larger managers. At ChrysCapital, there are plans to augment the two-person IR team and divide up client-facing and middle-office activities.

“Fundraising and IR are used interchangeably but they are a bit different. We think about fundraising as the front-facing part, the person who meets the LP and builds the relationship. Then there’s the project management side – DDQs [due diligence questionnaires], investor requests, creating presentations,” said Chatterjee, noting that global GPs have three people in project management for each person facing clients.

Feeding a need

Efforts to maximise touchpoints with LPs extend into thought leadership as well. Abu Dhabi-based Gulf Capital requires sector heads to produce white papers or thought pieces at regular intervals. Kaiser Jasrai, the firm’s head of IR and fundraising, described it as part of a broader information-sharing effort intended to help move LP relationships from sales-driven to collaborative.

The goal is to develop an ongoing dialogue in which the GP listens as much as it talks, resulting in a deeper understanding of an LP’s needs and how these might be met. For example, Gulf’s home region is peppered with sovereign entities that want to be more than passive investors in funds, whether that means using co-investment as a springboard to direct investment or leveraging portfolio relationships.

“Sovereign wealth funds are becoming more like strategic investors,” said Jasrai. “They are looking to attract knowledge, expertise, and technology into their home markets. Understanding that collaborative relationship is important. You want to make it a conversation or dialogue, so you are helping each other.”

Collaboration is not a sign of desperation, but managers across Asia are increasingly looking for ways to accommodate LPs in support of fundraising efforts. Co-investment opportunities are a powerful tool in this context – if not stapled to a fund commitment, then presented as a relationship-building exercise.

“Once you get that first co-investment, there is nothing to stop them from taking the next step. ‘I got comfortable working with your team, I like your strategy, so I will put money into the fund you are raising next,’” Brian Lee, general counsel at China-based FountainVest Partners, told the forum.

In addition to an influx in project funds to accommodate standalone co-investments, he has seen more managers secure credit facilities against first closes and use the capital to make initial investments. They want to smooth the path into the fund for other LPs by ensuring latecomers will not have to pay equalisation fees that reflect how portfolio valuations have appreciated since formal deployment began.

Depending on size, the classic fee discount incentive for those participating in first closes is now accompanied by increased bespoke structuring. This might involve sidecars and separately managed accounts that allow LPs to carve-out or double-down on certain opportunities or geographies, according to Bonnie Lo, a partner and COO at Asia secondaries specialist TPG NewQuest.

At the top end of the market, strategic relationships that cut across funds and strategies are being introduced. “It’s a win-win situation because the GP gets certainty over a long period of time and in a volatile market environment,” Lo added. “From an LP perspective, they get a special deal or a special look under the hood, and then some special economics that come with these relationships.”

For more established managers at least, there haven’t been drastic changes in terms and conditions. This is because LPs recognise that PE is a long-term game and markets fluctuate, said FountainVest’s Lee. However, they expect sensible dialogue on issues such as fee breaks on fund life extensions even if limited partnership agreements (LPA) proscribe that fees can be charged through final liquidation.

“They understand this is a tough time, so they say, ‘We aren’t going to squeeze it, but we want you to deliver what you said you would deliver and give me the co-investment to average down the price. And if you need to ask me for approval for an extension, I’m not breaching any LPA terms, I’m not renegotiating it, but let’s have an open discussion about what management fee fits to align interests,’” Lee explained.

Asia angst?

Such outcomes are feasible when relationships are strong and GPs – and their strategies – remain relevant. This can be achieved, at the manager level, by asking whether a product meets an LP’s needs and how it might be customised to solve for certain problems. It is tougher when the relevance of an entire region to a portfolio is under scrutiny.

When raising its early fund-of-funds, Asia Alternatives devoted a lot of time to investor education, explaining how it approached underwriting risks and returns in each market. Ten years ago, it seemed the message had sunk in, but Xu observed that the old questions are being asked again. Pandemic-related travel restrictions and uncertainty over China are seen as the key contributing factors.

At the same time, Asia Alternatives must respond to changes in the risk-return dynamic. It is not just a China issue; currency volatility, interest rates, energy prices, and various geopolitical tensions come into it as well. “We are constantly pushing ourselves to hold a higher bar, to be more selective, sharpen our pencils and look for higher return potential deals to compensate for the additional risk,” Xu said.

Resolving the valuation deadlock that is strangling deal flow would help, with Lee of Khazanah noting that the expectation gap in Asia is wider than elsewhere. In addition to liquidity, LPs value consistency – which can be harder to find in the region’s relatively shorter track records and fast-changing economies. Effective communication can pay dividends in this respect.

“We can be clear and enunciate what we are looking for. We’ve got a long track record now, so we can sit down and talk about mistakes we’ve made and refinements to the model,” said White of Next Capital. “You can have a much more interesting discussion with your LPs when you’ve been trying to deliver a consistent strategy.”