Captive of industry

A quick look at the Indian private equity landscape reveals that, besides the large global funds investing there, most of the established private equity firms are either affiliated to, or part of, larger financial services institutions.

It is through firms of this nature – the likes of ICICI Venture and IL&FS Investment Managers – that private equity has taken root in India. Later entrants such as IDFC Private Equity and Kotak Private Equity are also parts of larger financial services groups.

And in the last year, we have seen some of the most prominent Indian corporate houses, such as Tata Group, Aditya Birla Group and Reliance – Anil Dhirubhai Ambani Group, build private equity teams and hit the market to raise their own funds.

So why is it that India keeps throwing up one captive fund after another? Bharat Banka, managing director and chief operating officer of Mumbai-based Aditya Birla Private Equity, which is currently raising a fund targeting commitments of $250 million, provides an answer. “Look at the Indian markets. For the launch of multiple individually-sponsored funds, the environment and the banking and regulatory framework is yet to become conducive,” he says.

Ramesh Venkat, chief executive officer of Reliance Equity Advisors, which is currently targeting between INR15 billion ($320 million) and INR20 billion from domestic investors for the first tranche of its fundraising effort, provides another explanation. He says even the top private equity managers in India “don’t yet have a track record or the depth of experience to raise a large fund of their own”. An added factor, he says, is that the domestic LP market is also new to private equity – as such, these LPs too are more comfortable backing a larger, reputable sponsor than backing a relatively young independent team.

Convincing LPs

However, it is a common statement from Western LPs that they are disinclined to commit capital to teams that are affiliated to larger groups. Reasons for this include the model used to determine a share of the economics and the independence of decision-making at these firms. Without the higher financial incentives – and alignment – offered by independence, LPs believe GPs may not be as motivated to outperform. Likewise, the suspicion is that undue influence may be exercised by the parent company over the decisions made at affiliated firms.

“From the point of view [of LPs in the US and Western Europe], the sponsor is a drag on the economics and brings very little added value,” says Venkat, adding that emphasis is also placed on the private equity firm’s team and the quality of its track record.

However, the situation differs somewhat in Asia and the Middle East where LPs recognise that private equity is a new industry and a sponsor can play multiple helpful roles, says Venkat. A sponsor can help put the initial team together, then seed a fund and finally aid fundraising. In fact, in the Middle East, where many investors are high net worth individuals and family offices, captive funds affiliated to a strong brand name are often preferred by first-time private equity investors.

Besides that, in India, private equity investment options are relatively limited. Banka says LPs have a choice to either skip India altogether or consider three options. The first is to invest in a global or pan-regional fund, such as those managed by KKR and The Carlyle Group, “where you get exposure at the discretion of the manager”.

The second option is to invest in homegrown Indian managers that are either led by individuals or affiliated with institutions. But here, Banka says: “If you want to invest in non-affiliated funds, you are ignoring 80 percent of the market.” Finally, he says, LPs can play the public markets through hedge funds in PIPEs if they choose to.

Conflict of interest or coincidence of interest?

The challenge remains for a sponsored fund to demonstrate to LPs that their interests will be safeguarded and that there are means to address any conflicts of interests that may arise. Both fund managers spoken to for this article say they have been able to demonstrate to LPs and other potential investors that they have good incentivisation models in place which guarantee a fair share of the economics and carry to the teams they have in place.

Convincing LPs that they have they have effective mechanisms to address potential conflicts of interest is another challenge and firms go about addressing it in different ways.

For instance, the private equity arm of the Aditya Birla Group is focused on investing in capital light industries and hence there is an almost negligible overlap in terms of investment focus, Banka says. “This is a private equity practice within an institutional framework and linkage with the corporate group is a distinct advantage and not a condition,” he adds.

Furthermore, Banka goes on to say that Aditya Birla Private Equity has promised that its fund will not invest in any of the group companies, “so that generic overlap is addressed as well”.

In the case of Reliance Equity Advisors, on the other hand, any conflict situation with respect to a deal must be referred to an advisory board that will comprise of large LPs in the fund. In such cases, decisions cannot be arrived at by the investment committee alone. Reliance can, however, invest up to 10 percent of the fund’s capital in group companies or in companies related to the sponsor. When it is investing in a group company, such an investment can only be made if the firm can find at least one co-investor to come in on the deal on the same terms as itself.

Both Banka and Venkat are also quick to point out the many advantages affiliation to a powerful sponsor can offer on the investment and portfolio management side.

“The sponsor has access to a large number of corporates and industrial houses, and so can help open doors for us,” says Venkat. Besides, the parent company also has extensive operating teams across a number of businesses it owns whose expertise the private equity arm can draw on. Venkat is of the view that there is potential on the part of the sponsor to help the firm throughout the lifecycle of a deal.

Banka echoes the sentiment, saying the skill sets and success acquired through investments made by the parent group will work effectively for investments made by the group’s private equity funds. “The capabilities that we have developed within the group are unique, differentiated and replicable in portfolio companies,” he adds.

But why is it that corporate houses such as the Tata Group, Reliance and Birla of India are attracted to private equity? The answer, it seems, is twofold. Firstly, India still has a dearth of quality private equity fund managers, but a great private equity opportunity, and secondly, their foray into private equity, they say, is a natural extension of their financial services businesses.

For example, Banka says that two years back, the Aditya Birla Financial Services Group offered mutual funds catering to shorter-term return generation requirements and life insurance products catering to customers’ protection and long-term needs. The group then felt it could provide “an option of wealth-building” over a longer period of time to sophisticated and institutional investors and a private equity practice would be the right platform to do so.

Moreover, he says, there was a need to fill a strategic gap that existing private equity investors were not filling. He explains that until recently, “about 85 percent of fund managers christened as private equity funds in India operated closer to the hedge fund strategy, while still getting clubbed as private equity”. Of the remaining 15 percent, he says about 10-12 managers were indentifying good investment opportunities, but even then, seven or eight of them were passive investors merely plugging a financing gap.

Succession issues

One further worry with sponsored firms is that successful managers will outgrow the constraints imposed by their corporate parent and leave to establish independent firms. Presently, two private equity veterans, namely former CVCI India head Ajay Relan and former ICICI Venture chief executive Renuka Ramnath are attempting to do so.

Multiples Alternate Asset Management, the new venture set up by Ramnath, is targeting commitments of $400 million for its maiden fund. Relan’s CX Partners, on the other hand, has garnered commitments of more than $220 million for its debut fund, which is reportedly targeting between $400 million and $500 million. 

One Asia-focused fund of funds manager told PEI Asia recently that while unfavourable carry structures at captive funds could lead to departures from the private equity team, the fact remains that large institutions are far better placed than smaller, independent firms to ensure continuity, for there is no individual at an affiliate firm that cannot be replaced. Large institutions have sufficient resources at their disposal to ensure team continuity, despite the occasional setback.

Both Venkat and Banka say for individually-led funds to flourish, there need to be enough individuals in the market with a substantial amount of experience and that just isn’t the case in India – yet. Over the coming years, as teams build their own track records and gather experience, more managers may be able to branch out to raise large funds of their own, offers Venkat. “But is not going to happen anytime soon,” he cautions.

With such a framework in place in India, it should come as no surprise if yet another Indian corporate house soon decides it is time to raise third party capital for a private equity fund.

 

Case Study: ICICI Venture, one of India’s oldest captive funds

ICICI Venture was founded in 1988 as TDICI Limited, a joint venture between between ICICI Bank and the Unit Trust of India, which at the time was the only company providing local investors with the opportunity to access the capital markets.

In 1998, ICICI Bank acquired UTI’s stake in the joint venture and since then, ICICI Venture has been a fully-owned subsidiary of India’s largest private sector bank. The parent group’s other businesses besides banking include life insurance, securities, general insurance, asset management and home finance.

Today, the firm manages $2.5 billion across private equity, real estate and mezzanine, making it one of India’s largest homegrown private equity firms.

Recent developments at ICICI Venture might provide evidence to back the view that private equity firms affiliated with institutions are well-placed to deal with the departure of key personnel from their teams, as they have large institutional frameworks to facilitate the finding of replacements.

In April, Renuka Ramnath, who had been managing director and CEO of ICICI Venture since 2001, quit the firm after having worked with various businesses at ICICI for 23 years. Her exit gave rise to speculation that ICICI Venture may struggle to raise a new fund successfully.

Ramnath was replaced from within the organization by Vishakha Mulye, then the executive director of ICICI Lombard. Mulye, though not a private equity veteran, was also formerly the CFO of ICICI Bank from 2005-2007, and helped the bank raise close to $7 billion in equity and several billion dollars of debt financing.

Six months down the road from Ramnath’s departure, the firm raised $250 million for the first close of India Advantage Fund Series III entirely from domestic investors, giving pause to questions over the firm’s continuity.