To much of the world, East Asia looks like the powerhouse that will drive global economic growth in the 21st century. If so, that ought to make it a prime hunting ground for private equity (PE) firms from the West and elsewhere, which are paying increasing attention to the region.
True, there are many great opportunities. But Asia is a diverse market, where business conditions are often very different from what Western PE firms are accustomed to. Opportunities may look enticing in Korea, mediocre at best in Japan and somewhere in between in China.
The PE industry in Asia today is relatively small, according to three speakers at the 2012 Wharton Private Equity & Venture Capital Conference. The speakers, all from the "Investing in Asia" panel, said that while this might suggest there is plenty of room to grow, each of the three major economies in East Asia presents obstacles.
Japan is a difficult environment because of its long-standing economic troubles, said Takajiro Ishikawa, general manager for the financial business development division at Mitsubishi Corp. "It's sad, but private equity is in decline in Japan," he said. "If you talk to Japanese investors, there is hardly any appetite to invest in Japanese private equity."
The first PE firms entered the Japanese market in 1987, and the industry grew slowly to a peak fundraising year of 2005. Since then, economic malaise has hindered the stock market and made PE exits through initial public offerings unappealing, illustrating one of the main difficulties PE firms face in Japan, said Ishikawa. "The IPO window is basically shut." A key underlying problem: Japan's rapidly aging population threatens to undermine the growth needed to fuel the PE industry.
Some room for optimism remains because only about 2% of investable assets in Japan are in alternative investment classes like private equity and hedge funds, Ishikawa pointed out. But PE has been a hard sell, even though the issues associated with an aging population, sluggish economic growth and poor returns in the public markets would seem to make the higher returns offered by alternative investments enticing.
"So, we are … almost on a mission to provide an excuse to the investment community — that they really need to get out and invest in the alternative investment class," he said. "Otherwise, it's going to be too late" to get the investment growth that Japanese institutional investors will need.
Growth in Korea, Challenges in China
Conditions are more favorable in South Korea, said Young Gak Yun, founder and chairman of Samjong Investment Advisory. After the Asian financial crisis of 1997, "we saw a lot of foreign private equity funds coming to Korea and buying distressed assets, and they made lots of money after a few years." Seeing that, the government in 2004 enacted a PE law to encourage the industry. "In the beginning, it was a government-sponsored industry, and now the industry is growing."
About 180 PE funds now operate in South Korea, managing about $30 billion. The national pension fund, with $350 billion to manage, is a major PE sponsor, Yun said, typically providing half of a fund's assets, finding a strategic investor for the other half and then selecting a general partner to manage the fund.
China, while offering a fast-growing economy, also presents some serious challenges to PE, said Michael Sung Wook Chung, founding partner and head of distressed strategies for Arrowgrass Capital Partners. "As a general matter, Asia is the growth engine of the world right now," he said. While China's economic growth rate looks to be slowing somewhat, it still draws investor attention. What is more, the regulatory environment is loosening "slowly but surely." PE is not large, "but the growth potential is tremendous."
Ishikawa noted that his firm, which invests outside of Japan as well as inside, "has not done a private equity deal in China." Reasons include the high cost of potential acquisitions and regulatory roadblocks that make it hard for outside investors to get money out of the country. "There really aren't too many examples yet of people making a lot of money [on] private equity in China," he said.
Chung suggested that in order for private equity to grow in China, "the credit markets need to get deeper." Easier credit would allow PE firms to use more leverage, a key to boosting returns. Unfortunately, the debt crisis in Europe is hindering expansion of credit markets, he added.
Because the PE industry's footprint is small in Asia, a significant portion of the Asian funds allocated to PE investments chases opportunities in the West, the panelists said. "I see these limited partners looking for opportunities in Europe," Yun said, noting that the United States is also drawing Asian money. "The phenomenon of Asian capital moving out West is, I think, real and here."
With the slow economy depressing lending in Japan, many of the country's banks are looking to invest in western countries, added Ishikawa. A final difficulty for PE firms thinking of investing in Asia: a shortage of personnel with the required skills. "The talent pool of general partners will continue to be in the U.S. and Europe," he suggested.
And so, despite huge PE potential in Asia over the long run, it will likely be some time before conditions create a true PE boom in the East.