Q&A: Hong Kong Monetary Authority's Clara Chan
Clara Chan, CIO for private markets at the Hong Kong Monetary Authority, discusses ever-larger pan-Asian funds, approaches to co-investment, addressing economic volatility, and the evolving GP-LP relationship.
The Hong Kong Monetary Authority (HKMA) is responsible for the Exchange Fund, which is tasked with affecting the exchange value of the Hong Kong dollar to maintain monetary and financial system stability. As of December 2017, it had approximately $512 billion in assets, including a long-term growth portfolio (LTGP) of $30 billion. One-third of this portfolio was invested in private equity and the rest in real estate.
Q: As pan-regional funds become ever larger in Asia, should investors be concerned?
A: We need to look at the underlying reasons for the expansion. I would say that part of it reflects the natural evolution of the market in Asia: GPs have developed more experience over the years, LPs are now more comfortable investing in the region, and the market opportunity is growing. In some cases, these increases in fund size stem from inbound requests from investors that want to put more money to work with a handful of trusted GPs.
Q: In these situations, what do you focus on during due diligence?
A: The key questions are whether a GP has the capabilities to manage a larger fund and whether the macro and market conditions support such larger fund in terms of opportunity set. We talk to the founder and leadership to understand more about the state of the firm. We want to know where they expect to be five or 10 years from now in terms of AUM and strategy sweet spot. This is important because private equity is a people business. We also need the GP to justify the fund size increase by taking us through their deal pipeline and showing us how their team is developing. On top of all the figures and charts, it’s an interactive, dynamic and qualitative process. You can’t just look at the increase in fund size and say that the number of people should increase by a certain, proportionate amount. On pipeline, we focus on differentiating what is actionable and what is attractive. We conduct detailed analysis to assess whether a GP is spreading its efforts into areas outside its striking zone in terms of deal size, sector, and financial structure.
Q: How do you assess how much co-investment might be available alongside commitments to these funds?
A: We ask for detailed historical data with a breakdown on how many co-investments a GP has offered in the past, what they involved, and how they performed. Track record can’t speak for future deal flow and performance, but it’s an important reference. If a GP hasn’t offered any co-investment in its past five funds, it’s perhaps difficult to make a convincing case that it will offer attractive co-investment in the next one. Given the increased competition for co-investment and to the extent practicable, we request to have some documented rights for co-investment allocation. The challenge is that not all GPs have the same standards or flexibility in crafting co-investment language, especially on whether the allocation is to be made on a pro-rata basis or with the GP’s full discretion.
Q: What is the process for addressing these opportunities?
A: Our approach is to focus on good GPs and good deals, and to go big on the ones that we like. Noting the process and efforts spent, scale is important for us whilst balancing considerations such as concentration risk. Regarding internal team set-up, we have people who specialize in direct and co-investment as well as those who cover GP relationships. The latter will have a first read on whether a proposed co-investment deal is within the GP’s striking zone and how the GP team has done previously, based on their existing knowledge. Once you’ve worked with a GP for several years, you have a good sense of their areas of comparative strength and weakness. The co-investment people will then contribute by looking at deal-level specifics. Being collegial and able to tap the wisdom of people with different expertise within the team when looking at a deal has been a very productive approach for us.
Q: Has this approach changed in response to the recent uncertainty around macroeconomic stability, the sustainability of private market valuations, and so on?
A: For private equity, while conscious of the latest macro and market conditions, the long-term nature of this asset class remains intact. With that backdrop, we try to remain stable in terms of deployment but be cautious and disciplined in picking GPs and deals. We put a lot of emphasis on evaluating the defensiveness of investments and on stress-testing cases. For the latter, we have drawn reference from data of previous corrections – for example, the impact of the global financial crisis on growth, currency and other fronts.
Q: Meanwhile, infrastructure has become one of the priorities…
A: It’s a combination of the macroeconomic environment, characteristics of the infrastructure asset class and where we stand in terms of portfolio construction. For our private market portfolio, we started off building private equity exposure in different sectors and then real estate. Private market valuations are currently high, and there are ups and downs in cycles. Infrastructure is a good candidate to add more defensiveness and stability for the long term, especially when those assets are mission-criticaland proven in terms of operation. On this front, we are flexible in terms of geography and sector – it is all about risk-adjusted return. As for mode of entry, we are open-minded and can go in through funds, co-investments, and direct investments.
Q: When considering a new asset class or strategy, to what extent are existing GP relationships leveraged?
A: We have a high threshold in terms of GP selection for each asset class and strategy, so while we greatly value our GP relationships, we may not invest in each and every product launched by a single manager. We review on a case by case basis. We are candid in telling GPs what we are thinking about in terms of allocation and individual asset class, and proactive in sharing with them what we need or what we don’t consider suitable for our portfolio. On areas such as infrastructure where we also do direct investments, we are open in telling GPs that our model is neither to compete with GPs nor to do all the deals ourselves. We see a lot of room for collaboration.
Q: To what extent is customization – through products such as separate accounts – changing the relationship between large LPs and GPs?
A: Customization is a growing trend in the market. For institutional investors with scale that have been in the market for years, this is a positive because they are clear about what they have tried before and what they want to do further. The reality is that generally GPs are only willing to structure bespoke products or accounts with pools of capital over a certain size, meaning that some smaller investors might not be able to benefit from this trend.
Q: ESG is an increasing priority for many LPs. What impact is it having on investments?
A: A lot of people used to look at ESG as a cost center. Now they understand that, although there might be a cost associating with ESG implementation in the near term, it brings long-term benefits that are particularly aligned with the nature of private markets investment. We are pleased to witness more and more successful cases with clear ESG elements or requirements achieving good financial returns. We learn a lot every day on what could be done. For example, in a recent project that we are working on, ESG also covers an element of biodiversity, which is a very interesting topic.
Q: How do ESG considerations factor into engagement with portfolio GPs?
A: We are pragmatic and have tried to put things into context when reviewing GPs or projects. Certain issues – such as anti-corruption – are of a threshold nature, whilst others may have a spectrum for implementation depending on the details of the project. There may also be different requirements for various sectors and developed versus emerging markets. Among other things, we talk to our GPs partners, and issue due diligence questionnaires, at an early stage of a project. We want to get detailed information about their business practices and constraints, and on that basis, we set where the boundaries are and focus on areas that we should push. It’s a dynamic and interactive process.
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