What I Learned at SuperReturn Asia

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In the week of September 18, hundreds of private equity, private debt, real estate, and infrastructure professionals converged on Singapore for the annual SuperReturn Asia. At Partners Capital, we spend a lot of our time talking to deal makers in private asset classes and to leading thinkers in the investment world, but I rarely get the opportunity to meet so many in a week. So, it was a unique, once a year opportunity, to take stock and to meet with other investors, allocators, and LPs from around the world whom I do not necessarily have the opportunity to meet during the rest of the year.

I attended around 20 presentations and panels and spoke with more than 50 people during the week. I came back with four salient messages: i)?The traditional Private Equity model is challenged and focus on operational value-add will separate winners from losers; ii)?Even long-term investors are looking for sources of liquidity to fine tune private assets portfolios; iii)?The Asia Private asset landscape is rapidly shifting with a new opportunity set and many challenges for investors to address; and iv)?Private debt is an interesting asset class but hard to execute. ?

Challenges to the traditional Private Equity model

The fact that events such as SuperReturn even exist is a testimony to the success of private equity as an asset class over the past couple decades. Private Equity sponsors have been able to generate outsized returns through a combination of a)?growing earnings (revenue and profit margins) on the underlying business; b)?selling at a higher multiple of earnings than they purchased the business for (multiple expansion); and c)?using debt to enhance equity returns. In the past decade the tailwind of low interest rates and valuation multiple expansion has been a significant driver of returns. Between 2010 and 2015, multiple expansion represented 48% of the median Private Equity deal returns. Between 2016 and 2021, it expanded to more than 55%. Going forward, we believe that higher interest rates could act as more of a headwind and that multiple expansion will play a much more limited role in returns. On Chart 1, we show our expected split between the drivers of returns going forward, with multiple expansion dropping to an expected c.?25% of returns (excluding the impact of leverage).

?Chart 1: Median PE Total Enterprise Value Creation, by Year of Exit

I heard this dozens of times from allocators and LPs last week. What was not clear from last week is how most Private Equity GPs are actually changing their model to adapt to this new reality. According to AlpInvest, more than a quarter of GPs have no team dedicated to operational value creation at all, while many others rely on relatively soft touch models to influence the operational performance of their investee companies. This will require increased scrutiny from investors. My colleagues delved into this issue in more detail in a recent whitepaper where they propose a framework to evaluate the different models that Private Equity firms have adopted to add value to investee companies (see Chart 2) as well as a process to evaluate managers based on their approach to operational value creation.

Chart 2: Different Approaches to Value Add

Looking for liquidity in private assets markets

It is anecdotal, but I met a couple handful of investors who have long-term commitments to private equity but are not allocating at scale at the moment because they have found themselves overallocated to the asset class. We discussed this issue in the context of the Venture Capital portfolios of Asian Family Offices in June. A combination of limited distributions from GPs and decrease in the value of liquid portfolios have mechanically increased many investors relative allocation to Private Equity. It means that many long-term Private Equity investors are now looking to other solutions for generating liquidity from private assets to rebalance their portfolios. Private Equity secondaries (both LP- and GP-led[1] ) as a consequence are becoming more mainstream. According to Pitchbook, secondaries transactions were above US$100B in both 2021 and 2022 – a step change from the previous years. Separate data from Bain?&?Co shows that the relative size of the secondaries market vs. the primary market had doubled from 2021 to 2022, from c.?10% to c.?20%. Beyond significant growth, there has also been a shift in the structure of the market. We have historically found higher IRR opportunities in tail-end portfolios and other more complex situations (e.g., GP-led secondaries, fund restructurings, asset carveouts). Today, LP secondaries have also become an attractive part of the market as LPs seek to increase liquidity and ‘forced sellers’ look to exit private equity assets altogether. Buyers are however very discerning and able to cherry pick assets, especially when looking at Venture Capital and Growth Private Equity portfolios that have seen the highest discounts.

In addition to solving issues created by past allocations, investors are looking forward and futureproofing their portfolios. In this context, there was a strong feeling that this step-change may be here to stay and that secondaries are now a sub asset-class of their own for private asset investors. There is no silver bullet to address the liquidity issues within Private Equity and Private Assets in general. There was a sense that a range of tools and approaches would be required with a gradual move away from the traditional 10+ year close-ended fund structure to also incorporate new options for LPs with different liquidity profiles. In addition to secondaries, “evergreen” structures can work both investors with longer-term time horizons and others looking for small intermittent liquidity from an otherwise fully invested portfolio. In the past, these structures were seen as second-best and only a solution for investors who cannot afford access to the mainstream market via drawn-down structures. Both for Private Debt and for Private Equity, larger, sophisticated investors are now revisiting this assumption and considering some of these structures as one of the tools to build portfolios. Granted, these structures present risks – they do not guarantee liquidity[2] , they theoretically expose investors to “NAV risk[3] ” (where the investor relies on a non market-based pricing for the assets, both at entry and exit), and some offer less diversification[4] . Cash drag within the fund, often mentioned as a drawback, is somewhat of a red herring as most investors need to hold liquid assets in case of unplanned capital calls or lower than expected distributions. Compared to all but the largest and most sophisticated investors, evergreen funds are often better placed to manage this liquidity and put in place the required lending facilities. Most importantly, these structures provide increased flexibility, which in turn allows both to deploy the portfolio faster and to achieve higher average exposure to private assets thus potentially generating higher average returns.

Whether through secondaries, evergreen structures, or traditional drawdown funds, it is clear that allocators and LPs will think longer and harder about how to structure and deploy their private asset portfolio to achieve the right balance between return and liquidity. This came out loud and clear last week.

Asia: A new opportunity set

For the best part of a decade, China absorbed about half of the Private Equity volumes in Asia Pacific[5] . More capital attracted more talent, which in turn attracted more capital, and the China Private Equity and Venture Capital markets grew to represents the majority of Asia Pacific activity over a decade. Between 2012 and end of 2021, Greater China represented 51% of the dollar value of Private Equity and Venture Capital deals in Asia Pacific and a whopping 69% for Venture Capital. Geopolitics, Covid and the hard economic reality of a subdued economic recovery in China have disrupted this virtuous cycle. Between 2022 and now[6] , China ‘only’ represents around 20% of the Asia Pacific buy-out market. Though in decline, its share of Venture Capital volumes has remained high, but it was thanks to decreasing volumes across Asia Pacific. Chart 3 below provides more detailed data.

Chart 3: 2012-2023 APAC Buyout and Venture Deals

While it was less than clear in the main room with mostly GPs on stage, hallway chatter with investors point to a future with a much more geographically diverse market but also one more complicated to deploy capital into. This is not to say that China’s relevance will disappear entirely, just that most forward-looking investors are looking to strike-up new relationships in a more diverse set of geographies for future allocations.

In Private Equity, India, Southeast Asia, Japan and Australia were the most talked about markets. Japan, a market long forgotten by many investors, is getting a new lease of life with a deep ecosystem and structural tailwinds – e.g., succession issues or divesture of non-core corporate assets. Australia presents interesting opportunities that were much discussed during the last day of the conference, though given the size of the economy is it is likely to remain a niche market for many investors. Within this set however, only India, over the very long term, has a growth potential commensurate with the amount of capital that is looking to be deployed in the region. Southeast Asia, a large economy as a block, will have attractive opportunities driven by its strong demographics and positive economic outlook, but it remains a complex and fragmented market.

In Venture Capital, both India and Southeast Asia present very interesting opportunities with increased digitalisation of the local economy and, especially in India, the potential to nurture global technology firms with Asian roots. There however remains a challenge with exits; while China has a proven track-record in this area, it is still an unknown in other Asian markets.

Private debt in focus

Last but not least, there is a great deal of focus on private credit. The challenge is that execution remains difficult for most investors. A significant share of the conference was dedicated to Private Debt, and it was a frequent topic of discussion with other allocators and LPs. The main issue that investors face is execution of the strategy – it requires specialist knowledge, it requires deal flow and team capacity to constantly redeploy, and it requires an in-depth understanding of both the macro and micro landscapes. Specialist providers, who focus on complex and difficult to understand segments, are an attractive area of focus but they are difficult to assess and often impossible to access for all but the largest investors. In summary, most LPs are convinced that it is an asset class they should be focusing on; however, all but the largest, most sophisticated investors lack the capabilities to deploy at scale in the asset class.

And finally given the conference was in Singapore - Durians, durians, and even more durians!

Outside of the realms of private equity there was also scope for participants to discuss Singapore’s favourite fruit. Did you know that China represents 91% of the world’s demand for durians? It is apparently a multi-billion market, larger than the diamond market in China[7] ! This represents 821,500 tonnes of the smelly fruit crossing the Chinese border every year. It might be a niche opportunity, but it featured in one of the main speeches and then in many hallway conversations after that!

* * *

I came out of the conference both wary of the challenges ahead and excited by the opportunities that the ongoing transformation with the Private Asset industry presents for investors. Much of this is not fundamentally new for us as a firm, but it is clear that the next 12 months will be a turning point for how many investors structure, allocate and deploy their private asset portfolios.

[1] LP-led secondaries typically involve the sale of existing limited partner’s stake in the private equity fund, while GP-led secondaries involve the fund’s general partner selling assets from the fund

[2] Most vehicles offer quarterly, annual or bi-annual liquidity and have gates (typically 5% at the fund level for quarterly liquidity)

[3] NAV risk here refers to the probability of loss due to mis-valuation when the investors enter and exit the funds at NAV. ‘NAV risk’ arises when managers lack the ability to transparently and accurately value the underlying assets that do not have public market

[4] For example, our assessment is that a portfolio built through patient commitments to successive vintages of drawdown style structures across a diversified group of GPs can 5 to 10 times more diversified than an evergreen structure focused on co-investments

[5] Source: Goldman Sachs research; Preqin

[6] As of 29th September 2023

[7] Source: Goldman Sachs

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