Private markets set to grow in Asia as investors look to diversify beyond stocks

Private equity, private debt and other options attracting increasing attention in search for better returns and risk management

PUBLISHED : Wednesday, 28 March, 2018, 7:11pm
UPDATED : Thursday, 29 March, 2018, 3:20pm

While Asia’s stock markets have been performing well over the past year, other forms of investing in the region such as private equity have been quietly attracting vast amounts of capital and new investors seeking to diversify their activities.

The so-called private markets, which include private equity and private debt financing as well as buyouts and venture capital, are filling in gaps in demand as the investment landscape in the region matures and bringing new opportunities.

Private markets are attracting capital because institutional investors increasingly want to have a variety of asset types in their portfolios as economic trends affect private and public markets differently, according to Xia Mingchen, managing director at Philadelphia-based private markets investment firm Hamilton Lane.

“We are seeing more investment strategies such as buyouts, private credit, real estate and infrastructure deals,” Xia said.

“Increasingly, as the market is maturing, we are seeing more good managers in Asia. We can say with high conviction that there are now good funds with proven track records that we can invest in, compared to 10 years ago,” Xia said.

For example, private equity investment tends to be illiquid and less volatile, thus offering investors protection during a downturn in stock markets, analysts said.

Unlike buying public equity, which does not provide investors with a board seat, private equity investors with board seats can influence a company’s business operations by giving advice and strategy in order to create value aimed at generating greater investment returns.

More importantly, while private markets are arguably riskier than public markets, this also means they can generate higher returns than the stock markets.

Fundraising in Asia’s private equity market rose to US$60 billion in 2017 from US$54.7 billion in 2016, with around 60 per cent of the capital for China-related companies.

And private equity deal volume in Asia, when funds are actually “deployed” for investments, jumped 96 per cent to US$110 billion last year with a 4 per cent fall in the number of deals showing that deals were getting bigger, according to data from US consultant McKinsey. In contrast, North American deal rose 1 per cent to US$641 billion.

Asia’s private market now has some US$785 billion in assets under management, the biggest component of which is early stage venture capital and growth firms, reflecting the relatively early stage of development of the region’s market.

Private equity-backed buyouts in Asia reach record high in 2017

The surge in private market financing meanwhile is creating competition for good deals, which in turn is pushing investors to diversify more across assets, analysts said.

Passive investors such as limited partnerships are pressuring the active asset managers they invest in to expand into new asset classes other than private equity, to use their vast stocks of uncommitted capital.

That means that private debt, an asset category that barely existed 10 years ago, is could also be set to take off, especially because conventional forms of lending have so far not been able to deliver returns in Asia’s banking system, and have created a significant amount of non-performing loans, said Chris Ip, senior partner at McKinsey & Company in Hong Kong.

“As funds get bigger, they are starting to diversify into these other asset classes. Private debt is starting to step in,” Ip said.

The industry is getting more sophisticated, shifting away from the “cowboy era of raising money just to make a quick buck,” he said, meaning that asset managers are having to become more robust and more disciplined in building their compliance processes, research and data analytics.

More private equity-backed cross-border deals in China and Asia this year, says Grant Thornton

At the same time, the competition for deals is driving company valuations to new heights as firms see bigger profits and earnings.

While some see the rise in valuations as a continuation of a bull market that started around the financial crisis when more capital was deployed to private markets, others expressed concern.

“It is mind-boggling for a lot of people with valuations getting higher by the day,” said Andre Zhu Jianchong, partner in private equity, mergers and acquisitions practice in Asia at law firm White & Case.

“Private equity and venture capital funds that invest in growth-stage companies often only focus on the top one or two players in their industry so they don’t have a lot of projects to look at. That leads to high valuations as well.”

When the market values of internet giants like China’s Tencent and Alibaba reach US$400 billion to US$500 billion, and valuations of second-tier technology companies such as mobile phone maker Xiaomi hit US$100 billion, other smaller tech firms suddenly appear attractive, driving up their valuations too, Zhu added.