Many global allocators to private markets are cutting back exposure to Asia, citing economic uncertainty, unpalatable levels of risk, and underperformance of emerging markets. But not Federated Hermes Private Equity, formerly Hermes GPE. It will stay at approximately 20%.

“We like Asia for the opportunity to invest in relatively ‘boring’ businesses yet still achieve very attractive growth – industries that, in the West, would be considered quite cyclical and aligned with GDP. You get a pickup in Asia because you still have the penetration of that industry in the market,” said Christian Mankiewicz, head of portfolio management at Federated Hermes Private Equity.

The firm is currently deploying PEC V, its flagship co-investment fund that closed on USD 486m last year. It primarily targets buyout opportunities involving smaller, growth-oriented companies. PEC VI, currently in the pre-marketing phase, will do much the same, with Asia as a key building block.

Sweet spots in Asia include modern retail and education, driven by consumption growth. Education is especially appealing as a perceived beneficiary of aspirational spending tailwinds. These narratives are less prevalent in Europe or the US, making them attractive to enhance portfolio diversification.

Federated Hermes targets 2x returns at the fund level, although deals are underwritten on an individual basis. As of September, PEC I had delivered net distributions to paid-in (DPI) of 1.86x. The comparable figures for Funds II, III, and IV were 1.58x, 1.43x, and 0.43x.

While private equity globally has struggled to underwrite attractive returns in a climate of higher interest rates, Federated Hermes seeks comfort in lower leverage levels and growth-oriented, cash-flow-positive businesses. Last year, distributions across the entire PEC series amounted to USD 250m, down 2% year-on-year. Global PE exits declined 44%, according to Bain & Company.

Secondaries – including single-asset and multi-asset continuation vehicles, strip sales, and LP tenders – are another reliable source of returns. More than USD 2.2bn has been distributed through this channel since 2010.

Origin story

Federated Hermes is the product of a 2009 merger between Hermes Fund Managers, the principal asset manager of UK’s BT Pension Scheme, and Gartmore Group’s private equity fund-of-funds businesses. Ten years later, US-based Federated Investors acquired Hermes Fund Managers, forming Federated Hermes, which had USD 757.6bn of assets under management as of end-2023.

Money market assets accounted for nearly three-quarters of the portfolio. The firm had approximately USD 20.6bn in alternatives across private equity, real estate, infrastructure, and private credit. The private equity programme alone was worth USD 4.7bn, of which more than is in co-investments. For fund commitments and co-investments, cheque sizes are USD 10m-USD 30m.

BT Pension remains a significant client, having awarded a USD 1bn three-year mandate to Federated Hermes in 2022 with a 50-50 split between fund investments and direct co-investments. Last year, BT Pension and British Business Investments backed a newly launched European growth equity fund.

Other clients include UK-based Local Pensions Partnership Investments, Australian superannuation fund Hostplus, Canada Pension Plan Investment Board (CPPIB) and Samsung Life Insurance.

Federated Hermes is keen to leverage the private wealth segment as well, and the firm is contemplating opening an office in Hong Kong – in addition to its existing Singapore presence – to address wholesale distribution in Asia. Moreover, a Goldman Sachs analyst was recently hired to cultivate family offices and private wealth clients.

One of the challenges of targeting family offices in Asia is a widespread preference to develop in-house investment capabilities rather than outsource. Federated Hermes claims to maintain a competitive position by offering hard-to-access deals involving smaller companies, building diversified portfolios, and delivering consistent returns.

Picking partners

As of March, USD 4.5bn had been deployed across 278 co-investments globally. Asian deals come from the likes of China’s Trustar Capital, South Korea’s VIG Partners, and Australia’s Pacific Equity Partners, each of which is also represented in the private equity funds portfolio.

Federated Hermes doesn’t restrict its co-investment exposure to portfolio GPs; it also participates in deals alongside teams spinning out from well-known managers. According to Mankiewicz, those emerging GPs have outperformed their more established counterparts.

“As they build track records independently, they are highly motivated to make deals work. There is good alignments in terms of investment management,” he said. “They don’t have the same management fees as large funds to pay nice salaries and bonuses; it’s all about the performance.”

While these deals may deliver strong performance, identifying opportunities beyond familiar GP networks involves careful assessment of many candidates – Federated Hermes looks at nearly 800 annually and acts on 2% of them. Bandwidth quickly becomes an issue.

Federated Hermes has 25 professionals covering private equity, with collaboration between teams in Singapore, London, and New York. Quick decision-making is a priority, especially given it enters 80% of deals pre-syndication. In one recent European transaction, the firm tracked the opportunity in tandem with the GP for 18 months before peer investors expressed interest.

“The value we bring is we can work alongside GPs from very early on. This allows us to understand the company inside and out, so we can move quickly,” Mankiewicz said. “When a GP puts in an offer, they can say ‘Federated Hermes is here with the capital to do the deal’. That’s important for managers with smaller funds or those investing deal-by-deal.”

On the fund investment side, due diligence efforts include reference calls with LPs and C-suite executives who have worked with managers. The deepest insights, however, come from executing multiple deals alongside a manager.

Perceptions of risk

Within Asia, Federated Hermes has operated in developed and emerging markets. South Korea, Australia and Japan account for around 50% of investment in the region to date, reflecting the firm’s preference for control deals over minority growth equity. The rest is spread across Southeast Asia, India and China. It is most bullish on Japan and India.

Federated Hermes has been active in India since the early 2000s. The market has gravitated from opportunistic to core on the back of improvements in governance, GP quality, and company quality, as well as a rise in buyouts. “We see this shift aligning with our strategy,” Mankiewicz said.

Regarding China, however, Federated Hermes remains highly selective. There have been investments – including a traditional business services provider – but Mankiewicz is wary of the risks attached to investment in certain sectors.

“We think the overall market opportunity is interesting. So as global investors, it is something that we’re looking at. Where valuations are now versus a quarter ago, versus where they might be in a quarter is less relevant to us,” he said.

“We are more driven by the long-term profile of the deals and their outlook. We won’t rush into a market just because there appears to be a temporary dislocation.”