Much of the optimism around Japan private equity surrounds its more active investor community and solid dealflow. We spent a week in Tokyo in March digging deeper into these two positives and finding out what’s on managers’ and investors’ minds for our Japan Special 2019 (look out for more on this next week).

These four themes came to the fore:

  1. Japan private equity is delivering

Pension Fund Association head of private equity, Shuzo Takahashi, told PEI the market is one of the “best performing” in its portfolio, although he declined to disclose returns. Looking at vintage years 1992 to 2018, data from eFront Pevara show Japanese leveraged buyout funds are similar to their developed markets peers in terms of risk-return.

While exit overhang is the challenge for some of the older Asian funds, Japanese funds have been more efficient in exiting and generating returns, added Jeff Acton, a Tokyo-based managing director of Asia-focused investment banking advisor BDA Partners. “It comes as no surprise that Japan is now a top priority on pan-Asian and global funds’ radar, who are either looking to do buyouts or co-investments.”

  1. Momentum is now coming into the market

Japan has made encouraging progress on the acceptance of private equity. Managers are no longer seen as “vultures”, having gone through three or four rounds of fundraising and establishing themselves as a respectable option for sellers.

Japan has two key opportunities to offer: 2.5 million small and medium-sized enterprises facing succession issues; and troubled, industrials-linked sectors ripe for carve-outs. What’s more, banks are throwing money at deals – Japan’s negative interest rate policy means capital is cheap – and listed company valuations are much lower than other markets. GPs see an opportunity to improve margins.

  1. Going to Japan is “not that easy”

The last two years have seen an influx of new market entrants. Foreign firms have stepped up local hires and opened Tokyo outposts to better access dealflow and get closer to institutional investor capital.

But setting up in Japan is not always that easy. The biggest roadblock of all is talent. For foreigners, learning the local language and culture takes time, while very few locals have knowledge and experience in alternatives, investors told us.

The market also has a long memory. “If you make one misstep, it’s going to be very difficult as a fund to make new investments,” Acton said. “You have to toe the line in Japan and respect the wishes and desires of the management team.”

  1. The next five years will be crucial

Investors want to see how record capital raising and deployment in the last three years plays out. Growing the market to the next level will depend on domestic funds maintaining strong returns over the next five years. Competition is getting fierce, GPs and LPs told us.

“It’s always tough to decide how much to grow the fund size, but the general understanding among LPs is that they don’t want too large a fund,” a fund of funds manager said. A healthy dose of Japanese self-discipline must be employed.

Write to the author: carmela.m@peimedia.com