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Asian investors: a healthy source of capital for Europe?

European fundraisers, like those in other regions, have suffered from a slower and more deliberate investment pace among institutions. Many have looked west to the US for capital. But should they now be travelling east? Amy Carroll reports.

It's official: the Asian economy is now clawing its way back from the depths of financial crisis it experienced in the late 1990s. Much of the region is now enjoying phenomenal growth. The National Development and Reform Commission estimates China's GDP growth for 2003 will fall somewhere in the region of 8.3 per cent, despite the outbreak of SARS and war in Iraq. Korea and Japan are predicting growth of 5.5 per cent and 3.9 per cent respectively, far outstripping US forecasts of 2.6 per cent and UK forecasts of just two per cent.

Propelled into action by the shock of its sudden collapse, the foundations of Asia's economy have been rapidly and dramatically restructured to support its recovery. And, given the growth rates that we have seen in some of the region's primary markets, there can be little doubt that the Asian economy is rebounding.

Asia's private equity industry did not escape the wave of reform that has swept through the region's financial markets. It has been forced to face its fundamental weaknesses. Half-formed infrastructure has been brushed away and a space has now been cleared for a rapidly maturing and increasingly sophisticated and globally orientated marketplace.

Recent commentaries have focused on the increasingly attractive nature of Asian private equity and the escalating capital flows from Europe and the US into Asian markets. But far less emphasis has been placed on the steadily rising flow from Asian limited partners into foreign - and specifically European - funds. This burgeoning trend was one of the major areas of discussion at the recent Asia-Europe Connection Forum in London, organised by the Asia Venture Capital Journal.

Why Europe?
Tough economic conditions mean that US institutions are currently sitting on the sidelines and their European counterparts are almost equally immobile. An opportunity has therefore emerged for Asian institutional investors to take centre stage.

With the notable exceptions of the Singapore government and the Australian superannuation funds, Asia has not traditionally been seen as a fundraising destination. But as Japanese and Korean corporate pension plans and insurance companies begin exploring the private equity space and liquidity builds in countries such as China, Asian investors may be ready to look overseas. It's already starting to happen. Approximately 25 per cent of commitments to Permira's recently closed E5bn fund were secured from Asian investors. Roughly the same proportion is also true of Doughty Hanson's and Terra Firma's latest fundraisings.

But why are institutional investors, in what is now the fastest growing economy in the world, looking to Europe to make their private equity fund investments?

One simple suggestion made was that the domestic chaos brought about by the Asian crisis forced Asian institutions to assume a more global perspective when considering their investments. There simply weren't enough healthy opportunities at home. ‘Japanese investors never really had to look abroad before the crash,' explained Kazuo Seki, president and CEO of Mitsubishi's Alternative Investment Capital. ‘With things as they were in Japan we were forced to shift more towards overseas investment opportunities.'

Europe was an obvious place for them to start looking. Asia's investment connection with Europe is historical and spans centuries. And despite pronounced cultural differences, the European business environment is perhaps less alien to Asian investors than it may at first appear. ‘What European groups have to offer Asia is decades-long experience at the negotiating table and an ability to deal in a multicultural, multilingual environment that is as widely varying as Asia's diverse landscape,' said Dan Schwartz of the Asian Venture Capital Journal.

But there are also more immediate reasons why Asian institutional investors are beginning to look to Europe. With the Asian private equity market still in its formative stages and the US market sluggish there is a genuine lack of viable alternatives for Asian LPs that wish to have an allocation to the asset class.

European buy-out funds that have held closes in 2003 have raised a total of E13bn, while US buy-out funds have raised just $9.2bn, according to statistics produced by AltAssets. These figures represent a dramatic reversal of the traditional pattern. In the same period last year European funds raised E16.2bn and US funds raised $28bn.

This is a trend that is set to accelerate by all accounts. Eng Seng Ang, head of GIC Special Investment's European private equity initiative, explained that his organisation was gradually increasing its allocation to European private equity at the expense of the US market. The firm currently allocates half of its capital to the US, one-third to Europe and the rest to Asia. But this balance is set to shift. ‘Investment pace in Europe is speeding up and investment pace in the US is slowing down. The gap is gradually closing,' Eng Seng said. ‘Our allocation to Europe is growing to reflect of this and if we continue to find good managers in Europe I would expect this trend to continue.' Seki agreed. ‘We currently allocate 60 per cent to the US, 30 per cent to Europe and ten per cent to Asia. The US is slowing down, so our allocation to Europe and Asia is set to increase.'

Hideya Sadanaga, head of private equity at Nippon Life Insurance International, had a similar story to tell. ‘Historically, we have allocated 70 per cent of our private equity commitments to the US, 20 per cent to Europe and ten per cent to Asia. But our allocation to Europe is going to go up to more like 30 per cent. It's an exciting market and the fact that the US funds are coming over to invest is evidence of that.'

Why not Europe?
But before European funds start booking their plane tickets, they should be aware that there are some limiting factors to the capital flows from Asia. Despite the endorsement of limited partners such as Sadanaga, Seki and Eng Seng, and the Asian fundraising successes recently enjoyed by some high profile mega-funds, it remains to be seen whether Asian institutional investors will be prepared to commit serious money to European funds on a consistent and long-term basis. ‘Our overall view of the European private equity market is one of a generally positive outlook, and it is definitely a region where we would like to do more,' said Sadanaga. ‘But to be honest, I am not sure that when it comes down to it there will be too many other Asian investors prepared to make serious commitments to Europe.'

One of the reasons offered for this is a lack of widespread sophistication and global awareness among Asian institutional investors. Some of the larger institutions are clearly becoming familiar with the European market. But there are many more that are simply too small to operate on an international level or that remain sceptical of the unknown. ‘Despite rapid growth in Asia, it actually isn't true that we have a large number of institutions that are ready to play the game globally,' said Tuck-Seng Low, managing and founding partner of STAC Partners.

There are also a number of other factors. Eng-Seng cited capital control issues in countries such as China as one such limiting force. He went on to say that, just like their Western counterparts, many Asian investors have also been put off investing in Europe by their experiences, direct or otherwise, of its recent boom and bust. Sadanaga added that a major reason for not investing in European private equity was the currency risk involved with international investment. ‘Currency loss places an inherent limit on how much capital we can employ in overseas private equity. It simply comes down to the cost of capital. We need to be sure that we generate suitably high returns to compensate for these losses and private equity is rarely so certain an asset class.'

A question of returns
Ultimately, as is to be expected, Asian institutional investors make investment decisions on the same basis as European or US institutional investors do: the balance of risk and returns. Although the private equity players at the Asia-European Connection Forum discussed a multitude of reasons why the private equity flow from Asia towards Europe may or may not flourish in the future, time and time again talk came back to the potential and reality of returns. ‘Asians are practical investors and they need to see results,' said David Goss of the United Overseas Bank Global. ‘Risk and reward need to be balanced for Asian limited partners in Europe, they need to be brought into line. The only question we can ask ourselves is whether Asian investors can accept the risk-adjusted returns that Europe has to offer.'

‘Historically our investments in Europe have outperformed those in both the US and Asia,' said Eng-Seng. ‘I will be keeping an eye on anything that could affect these returns. I will be watching to see the effect that increased competition in the European market has on returns, just as I will be watching to see the types of returns that are generated by all these secondary buy-outs. It's all about returns.'

‘We aspire to generating high returns like everyone else,' Sadanaga added. ‘If Europe can deliver then we will continue to invest.'

The future
Asia's involvement with private equity on a global scale is still relatively immature and it is difficult to say at this stage which direction future developments will take, as Christopher Brotchie, managing director of Baring Private Equity Partners said:‘Constant change is about the only thing our industry has been able to count on in Asia.'

But if the flow of capital from Asia to Europe is to become a consistent and prominent feature on global private equity landscape, then it is important that a number of things happen over the next five to ten years.

One of these is that a cultural affinity to private equity continues to evolve in the Asian business world and that investors in Asia become more comfortable with it as an asset class. Another is that Asian institutional investors are educated about the opportunities that Europe has to offer them. ‘There is an education that needs to take place in Asia about Europe, because the story just isn't known,' said Goss.

But if Europe is to strengthen this private equity link with Asia then above all it must be able to deliver on its promises. Many Asian limited partners are new to the industry and they need to see results before they can confidently commit on a larger scale to the region's funds. European funds must be seen to be generating the types of returns that Asian investors are demanding if private equity capital is to continue flowing freely between Asia and Europe.

‘Asian investors are hugely important to us right now,' said Charles Sherwood of Permira. ‘But that is nothing compared to the importance that we hope they will have down the road.'

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