LPs diversify their private equity portfolio by investment strategy, such as buyout, venture capital, and private debt, but also by geographic region – developed markets versus emerging markets – and of course the subregions and countries within these broader categories. When it comes to regional diversification, the more “traditional” institutional LP is likely to have a private equity portfolio that is biased towards North America simply due to the breadth, depth, and maturity of that market. However, Asia is an increasingly more important component of LP portfolios, and nothing proves this more than just the sheer number and capital volumes raised for Asia focused funds. LP appetite for Asia private equity is on the rise, but is it justified?
Asia PE has matured and developed dramatically over the past 15 years – I remember doing due diligence on Asia funds back in 2005 and at that time, Asia PE was emerging; right or wrong, we viewed Asia with a lot of inherent risks that you are less likely to encounter in the US or western European PE markets. Despite the risks and our doubts, it was undeniable that hyper economic growth was driving some phenomenal (and unbelievable) returns. Few GPs in those days had dedicated value creation Ops Teams because it just wasn’t necessary. As a relatively conservative LP, our portfolio included just a handful of Asia funds.
Fast forward to today and most LPs investing in PE probably already have more than just a toe in the Asia market. Quite a number of established Asia GPs are now into their 7th or 8th fund generation, raising fresh capital from new LPs and also re-ups from existing LPs. And then there are the investment professionals who have developed a personal track record and spun out from these older GP firms to set up their own fund – the Asia opportunity set for LPs is as broad and diverse as it ever has been, and Asia PE is now much more mainstream than it was 10 to 15 years ago. However, the premise for LPs investing in Asia PE is not only for the sake of portfolio diversification but also with the aim to achieve higher returns and outperformance, and some of the underlying drivers behind the superior returns in emerging Asia include macro-economies that are growing at a faster pace than the developed markets, and structural shifts like a growing middle class, increasing wealth creation, and consumer spending, and market reforms. But now that we are about to start the second decade of the 21st century, do the returns in Asia over the past 15 years prove the region is worth investing in compared to the North American market?
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In this blog series on Asia private equity, we will be addressing this question by exploring fund-level net returns, deal level gross returns as well as deal level operating analysis, all in the context of comparing Asia against the North American PE market to understand what we can learn from actual historical performance. This series and the analysis presented is based on the CEPRES Platform and its primary-sourced, cash flow based private equity database on over 7,600 private markets funds and over 77k underlying portfolio companies. Specifically for the first part on fund returns, we are talking about 2,541 North America focused funds between vintage years 2004 and 2018, and 508 Asia focused funds for the same vintage period. As expected, there is clearly more data available on the North American market, but with over 500 funds spread across 15 years, statistically relevant observations on Asia can still be drawn from the analysis results.
Asia vs. North America: benchmarking net IRR returns
Referring to Figure 1, we are showing median fund net IRRs with Asia displayed as Market Data (shown in solid blue) and North America is the Benchmark (shown in blue stripe). Asia outperformed by a wide margin before GFC in 2004 and 2005, but during GFC years 2007 through 2011, North America funds were clearly superior in the median. In more recent years since 2012, Asia outperformed in five out of the seven years, and on an overall basis across the past 15 years, the two regions are actually very close in net IRR performance.
If we look at top-quartile funds as shown in Figure 2, the pattern is similar: Asia outperforms during pre-GFC and again in more recent years since 2012 in six out of seven years, and the margin widens when measured on an overall basis. During a difficult market environment, North American funds are better than Asia funds when measured by net IRR, while the latter is stronger across almost all other vintage years.
So far, historical fund net IRRs are showing a compelling case for investing Asia focused funds, but in the next article, we will take a closer look at fund net DPIs to show actual cash-on-cash returns to LPs and eliminate the effects of unrealized valuations and cash flow timing posed by IRR calculations.
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