Private markets investors from some of the world’s biggest investment groups believe that Southeast Asia’s “moment in the sun” has arrived, but only fund managers with the ability to deliver long-term, high-quality returns can seize the opportunity.
Sunil Mishra, a Singapore-based partner at Adams Street Partners, said he is seeing an increased interest from global limited partners (LPs) in allocating capital to emerging markets across Southeast Asia, after getting over 50 reference calls from his counterparts in the LP community over the past 12 months.
The dozens of calls came from global LPs “who have never looked at Southeast Asia in the past, trying to understand what it is that they can do here”, Mishra shared during a panel discussion at DealStreeAsia’s Asia PE-VC Summit 2023, which was organised in Singapore on Sept 5 & 6.
At Adams Street, which manages $55 billion in assets for over 600 institutional investors, Mishra specialises in fund selection, due diligence, and monitoring of Asian investments, specifically in India, Southeast Asia, Australia, Japan, and Korea.
“Interestingly, we always used to say that the fundamentals and macro stories of Southeast Asia are very attractive. But what we really lacked was micro stories—GPs who are consistently delivering high-quality returns,” said Mishra at a panel discussion titled ‘The LP View: How are asset allocators looking at the SEA opportunity?‘ at the Summit.
A renaissance of Climate and Impact funds
Climate and Impact funds are areas in which GPs in Southeast Asia are trying to catch up with their developed-market peers to woo deep-pocketed LPs like the International Finance Corp (IFC), the World Bank’s private investment arm.
With more global LPs researching the market, Saima Rehman, an investment officer in the Disruptive Tech & Funds Group of the IFC, said in the same panel that it can “only be a positive thing”.
While GPs in the region could diversify their LP cap tables, Rehman said: “The fact that we have more experienced institutional LPs coming to the region and finally recognising it as a separate sub-region within Asia means that we will hopefully get better global practices built into our LPACs [Limited Partner Advisory Committees], governance, and LPA [limited partnership agreement] documents.”
“Climate and impact funds are having a renaissance right now,” said Rehman. “We’re finally seeing some real conviction around it. There’s also [an] LP push towards allocating capital as long as you [the GPs] fulfil certain criteria.”
Best practices for Asia funds
Lay Hong Lee, managing director of Flexstone Partners, was also among the panellists.
They all agreed that practices similar to the private fund expense and disclosure rules from the US Securities and Exchange Commission (SEC) will also be adopted by Asian and global funds soon.
To increase transparency, fairness, and accountability in the industry, the SEC in August implemented new rules that require private funds to issue quarterly fee and performance reports and to perform audits. The changes also require that funds disclose certain fee structures and bar them from offering some investors preferential treatment when it comes to their portfolio exposures and ability to cash out.
“I think what the SEC has done is to put on paper what a lot of LPs have been muttering under their breath,” said Hong Lee. “Even though it’s in the US, a lot of these are best practices that can be adopted for Asia funds as well.”
Based in Singapore, Lee is responsible for the investment execution and portfolio management of the Asia team at Flexstone Partners, an affiliate of the asset management giant Natixis Investment Managers.
Lee, whose work covers fund valuation and reporting matters, pointed to continuation funds as one of the areas where some LPs may find it particularly challenging to navigate without full transparency. As exits remain difficult, private fund managers deploy the so-called continuation funds when they want to keep managing their assets from traditional funds that are about to mature.
In the private funds industry long criticised for its opacity, continuation funds pose challenges to certain LPs, such as pension funds, who are unable to take the roll-over opportunity due to a lack of relevant resources to evaluate direct deals.
“I know a lot of pension funds who are not able to do it because of the structure that they are in and the [limitation of] resources,” said Lee. “Most of them would sell. And they get frustrated because they know the valuations are not right.”
Edited excerpts from the panel.
What are your views on the comments made by GIC’s chief investment officer Jeffrey Jaensubhakij that the golden age for private equity firms has “come to an end”.
Lay Hong Lee: To me, I think we will all adapt and work out new ways of doing things. It’s not a concern for me. [For] Flextone, in particular, we are focused on the small to middle market. So far, deal flows are still good. We are still seeing deals in the market and deals getting completed.
Sunil Mishra: It’s the end of an era, but I’m sure it’s the start of a new era. The playbook, which was quite successful especially in the developed world, will need revisiting. In the last five to seven years, a lot of top-tier GPs were talking about us being at a late [stage of a] cycle—prices were high, even though leverage was cheap. They were always talking about what was the next way of creating value and generating alpha.
“The playbook, which was quite successful especially in the developed world, will need revisiting.”
We saw a lot of people’s playbooks change… [with] a lot more orbiting partners and a lot more active engagement in companies. Maybe it is the end of an era for simple financial engineering. I think more sophisticated financial engineering will remain. A lot of managers are aware that, at some stage, [when] the music stops, they will need to take control of their businesses and portfolio companies.
We strongly believe private equity is one of the better ownership models, because you can control a lot of levers in the business. So, with respect to any other asset class, I think outperformance will remain… That’s why we are long-term secularly bullish on it.
What is your outlook for the tech sector, where we have seen a lot more down rounds and valuation resets in the past few years?
Saima Rehman: The outlook, at least for the rest of the year, is going to remain restricted. We all know what has happened to valuations. Internet- and tech-focused funds have found it harder and harder to raise capital—not only raising less than targets but also taking longer to close. In addition to that, we’re in a high interest-rate environment.
We’re moving out of… a herd mentality, especially in 2021 when valuations went through the roof. We’re finally seeing multiples come down and managers pay attention to portfolio management rather than dealmaking.
“We’re finally seeing managers pay attention to portfolio management rather than dealmaking.”
We’re seeing VC managers pay more attention to sustainability and fundamentals. I think that return to discipline is tempered somewhat by the fact that a lot of managers had an investment thesis that was based on an exit scenario, which just won’t happen.
Lay Hong Lee: The idea that market cycles come and go and that valuations do come down has helped rationalise some of these investments. People are looking to do investments better. I see a lot of our GPs rolling up their sleeves, getting into operating, and talking about controlling costs.
What do you make of the new rules adopted by the SEC in August that require private funds to issue quarterly fee and performance reports?
Lay Hong Lee: I think what the SEC has done is to put on paper what a lot of LPs have been muttering under their breath. A lot of the rules bring discipline into the GP process. Even though it’s in the US, a lot of these are best practices that can be adopted for Asia funds as well.
Sunil Mishra: I think it’s going to become global very quickly. It is going to become mainstream, which is what the industry wanted as they explore new fundraising frontiers. I think this is important because not all LPs have the same level of sophistication and access to information and disclosure. How do you ensure that nobody is marginalised? Like listed equities, you take care of minority shareholders… If a GP wants to run a business that scales and becomes institutional they need to adopt the best of the best standards for disclosure and transparency.
Saima Rehman: For decades, private equity has been probably the least regulated sector of our capital markets. GPs have enjoyed that but there have been issues with fees, expenses, side letters, and disclosures. These are extremely important LP issues… I think the SEC is finally protecting smaller, and in some cases, medium investors.
“If you’re a GP with nothing to hide, how does it matter if you’re disclosing information?”
Another thing to keep in mind is: The naysayers to the recent SEC rules have basically said: “Look, you’re stifling competition and innovation.” I think If you say that, that means you’ve got something to be scared of. If you’re a GP who has nothing to hide, why does it matter if you’re disclosing the same information to everybody? If you’re a GP and you didn’t see this coming, you’ve been sleeping. I think in Asia, Hong Kong and Singapore are going to be one of the first regulators to start implementing this.
What are the other issues that can be improved?
Saima Rehman: Transparency and governance are top of mind for me. I think transparency is very fluid. Despite similar reporting and disclosure requirements across a standard set of industry documents, you have very different levels of practice and implementation. The next thing is it [transparency] goes hand in hand [with] the governance of funds.
Sunil Mishra: GPs have accelerated their investment pace, thinking that the innovation pace has increased so they need to invest faster. Once you get onto that bandwagon… you’re investing fast, and you’re missing things. You’re taking some shortcuts or not able to remain on top of the things that you already have. It just kind of goes down from there.
This is a long-term business. And if you can’t execute with the same details on different days, and at some stage, your portfolio builds up but your exits drop, the whole machine will just come to a stop. There has been a lack of appreciation for that, as people have built very large firms. This is a good time to take a reset and understand that. As much as LPs love you and want to give you a lot of money, at some stage, they want it back as well.
“Fund managers need to realise that they can’t take more than they can bite.”
Lay Hong Lee: Fund managers need to realise that they can’t take more than they can bite. In my 20 years in private equity, I have only seen one manager – kudos to him. He raised, I think, a $1.5-billion fund. And then he realised that the market wasn’t going the way that he expected, so he cut his fund size to $900 million around two years into the fund’s investment and returned his LPs the management fees that were paid on committed capital from day one. By the way, he did very well for the fund. I would say that when you respect your LPs, they respect you as well. And they will come back to you if you get the returns.
Your views on China opportunities.
Lay Hong Lee: Unfortunately, the weaker-than-expected recovery from China has fuelled a lot of concerns in terms of the prospects… There’s this flight to quality, and the war in Ukraine is not helping China. We actually have investors who told us to hold back on China for now. But we think that China will come out of this. It will take a while, but to remain invested is the right thing to do.
What about Southeast Asia?
Sunil Mishra: I guess this is the moment in the sun for Southeast Asia. Finally, there is a little bit more appetite and more balanced allocation in the Asian context from global LPs and capital allocators. Interestingly, we always used to say that the fundamentals and macro stories of Southeast Asia are very attractive. But what we really lacked was micro stories—GPs who are consistently delivering high-quality returns. LPs can only listen to macro stories, but we can’t invest in them. We need a GP who converts that macro story into LP returns.
In the last 12 months, I must have gotten more than 50 reference calls from many global LPs who have never looked at Southeast Asia in the past, trying to understand what it is that they can do here, which I think is a great sign.
With new global LPs looking at Southeast Asia, what does it mean for LPs who have traditionally been the top allocators to this region?
Saima Rehman: I think that can only be a positive thing. First and foremost, there’s more choice at least from a GP point of view… Firstly, it gives you more choice in the types of LPs that you can have on your LP cap table. Secondly, I think the fact that we have more experienced institutional LPs coming to the region and finally recognising it as a separate sub-region within Asia means that we will hopefully get better global practices built into our LPACs (Limited Partner Advisory Committees), governance, and LPA (limited partnership agreement) documents.
From an LP point of view, we now need to make a concerted effort to get into a top-tier fund. That’s not a bad thing, either. I think the more participation we have from the global LP community in Southeast Asia, the better.
Secondary deals and continuation funds are finally taking off in Asia. Do you think the LP interest is truly protected in the implementation of such deals?
Lay Hong Lee: The grand idea of continuation funds is that the GP has a trophy deal(s) with a valuation that is not great, so they are not willing to sell. My issue with this is that the valuation is never what you think is ideal. Clearly, continuation funds are not valuing their trophies well. If I were an LP in such a fund, I would be thinking: “Am I taken for a ride?” The secondary market is somehow a taboo in Southeast Asia, versus Europe and the US, where such deals are “so common. The gradual change of the market perception around secondaries would grow the PE market a lot more in Asia.
Sunil Mishra: The way we think about continuation vehicles is that it’s a liquidity tool. It’s just like when you take a company for an IPO or when you sell it in a trade sale. They do not believe that they are able to extract the premium at this stage of the exit. So, maybe it makes sense for them to find a better market opportunity.
We always ask the GP that they should give LPs the roll-over opportunity. If someone has the horizon to participate in the outcome, they should be able to participate in the outcome… I think it’s a mode of exit that GPs should selectively consider, and LPs should also consider when it makes sense for them.
Where do you see opportunities in allocating to climate and impact funds in Southeast Asia, particularly at this time?
Saima Rehman: Generally speaking, climate and impact funds are having a renaissance right now. Luckily, it’s not just people saying that they’re going to raise this type of funds, simply because that’s what’s popular. We’re finally seeing some real conviction around it. There’s also [a] serious LP push towards allocating capital as long as you fulfil certain criteria.
“Climate and impact funds are having a renaissance right now.”
We’ve had tech and VC GPs come to IFC, fully cognisant that they may not be able to raise capital from us, but just have meetings and say: Look, can you just explain your ESG framework and your impact framework? How does it work? I think impact and ESG are here to stay. Allocations will increase.
What happens if your GPs are unable to fulfil your ESG standards?
Saima Rehman: If it happens to be one of those rare cases of a GP taking the money but not following through on ESG commitments, we will either find a way to get out of the fund or you’re never going to see money from us.
Sunil Mishra: We’ve realised that your value creation ability will be compromised. The follow-on investors and the buyers of an asset are looking for all these [ESG] things. This is a value maximisation initiative… We do this continuous monitoring, talk to the GP, and work out a plan on how they’re going to improve on this. If there is no intent, we’ll find a way out. There’s a secondary market that we just talked about.
Any advice for first-time fund managers?
Saima Rehman: You have to focus on the fundamentals… What is it that you’re trying to do? Does your strategy match your experience? Does your team hold up to that strategy? Can you show us a credible pipeline that is willing to wait for your fundraising? Do you have at least some ways to either do one or two deals that you could warehouse, or show us a little bit of a track record before you go in? Track record is king… So, focus on your track record. Show us that you can return money to LPs. And show us that the opportunity set that you are targeting matches the fund that you’re raising.
Sunil Mishra: At this stage, the most important thing is a realised prior track record… You should at least be in the first or second quartile. If you are not, it’s going to be really tough.
Lay Hong Lee: First-time managers, I assume, are not first-time investors. My advice is: Don’t be in a hurry to raise funds. I have seen independent, experienced investors who came out of companies like KKR and Blackstone start their own funds… Show people that you can still do good deals, get co-investors, and get the deals done without the Blackstone and the KKR behind you.
