Key trends in Japanese private equity

Despite challenges, signs point to a market that has begun realising its potential.

Key trend 1Demographic trends open doors to deals

Japan has been grappling with a challenging demographic trend for some time now – its population is falling and ageing. At one end of the spectrum, the country has one of the lowest birth rates globally. At the other, it has the highest proportion of over 65s in the world, with the exception of Monaco, according to World Bank data.

Prime minister Fumio Kishida emphasised the urgency of Japan’s demographic crisis in a parliamentary speech in January, in which he argued that “focusing attention on policies regarding children and child-rearing is an issue that cannot wait and cannot be postponed”.

Japan’s efforts to encourage higher birth rates alongside the need to support a growing elderly population also point to a role for private equity, which, as an industry, has long looked to invest behind mega-trends such as demographic shifts.

Services for the elderly, for example, such as nursing homes and healthcare, are coming under increasing demand, offering opportunities for private equity to grow businesses in these areas.

Meanwhile, the owners of family-run firms are also ageing and many of them are finding themselves without a successor to take the reins. A survey conducted by Teikoku Databank found that, as of 2020, as many as 65 percent of Japanese companies lacked a successor. This presents a gap which private equity is poised to fill.

As Clifford Chance partner Michihiro Nishi tells Private Equity International: “Succession issues are so widespread that it is a significant investment theme for several PE houses. The business owners are often looking to sell after facing limited options due to a lack of suitable successors. From the PE house’s perspective, while they can obtain a profitable business at a discount, they will also modernise and improve the business.”

Succession-based deals continue to gain momentum as the country’s business community becomes more accustomed to private equity buyouts and the operational improvements that these new owners can deliver. But it’s not just family-run companies where PE funds are putting their value-creation skills to use – carve-outs also remain a significant source of opportunity in the region.

“There are a lot of businesses in Japan that have previously been under-managed, that are non-core and have lacked investment. That means there are plenty of hidden gems in corporate portfolios,” says Tatsuya Ochi, head of Partners Group’s private equity direct investment business in Japan.

Key number 2Japanese LPs carefully consider commitments

While dealflow is fairly robust, Japan’s PE industry is coming up against some constraints. Like many LPs, Japanese institutions have found themselves grappling with the denominator effect.

However, for Japan’s LPs, this issue has been further compounded by the weakening of the yen relative to the US dollar. This has had a knock on effect on re-ups and new commitments, as capital constraints have forced some LPs to write smaller cheques and be more discerning about the funds and managers they back.

“Investors have to become more selective in terms of which GP they want to re-up with,” says Miho Hosoya, a senior consultant at Mercer. “Of course, some investors may have reduced the average ticket sizes, but at the same time I think most investors are trying to be more selective in terms of the tickets that they invest.”

Overallocation issues could also prompt LPs to turn to the secondaries market to offload fund stakes, a move that an executive at a Japanese LP gatekeeper told PEI some of its clients were “seriously considering”. Pricing challenges, exacerbated by valuation volatility and a disconnect between seller and buyer expectations, may have made some LPs hesitant to transact on the secondaries market over the last year, but some sizeable portfolios have been put up for sale. In March, for example, affiliate title Buyouts reported that Norinchukin Bank, which supports Japan’s fishing, agriculture and forestry industries, was shopping a large portfolio of private equity fund stakes on the secondaries market. Sources sized the portfolio sale at around $1.5 billion or more.

However, such processes, whether instigated by local institutions or those based outside of Japan, could be a boon for other LPs looking to buy.

“What we see this year is that LP interest transactions are likely to increase because many US and European investors are suffering from overexposure and the denominator effect. I like these opportunities because they allow us to access the old vintage funds and mitigate the J-curve,” Yasuyuki Tomita, head of PE investments at the Japan Science and Technology Agency’s university endowment, tells PEI. “Our PE programme started last October, so I want to access vintages from before that time.”

JST is not the only university endowment that appears to remain bullish on alternatives. Last August, PEI reported that the Tokyo University of Science had increased its allocation to private equity from 20 percent to 25 percent in its fiscal-year 2022 portfolio plan.

There are also less traditional investor profiles that could provide welcome sources of capital to the country’s private equity market. For example, private markets fundraising platform LUCA recently launched a beta version in Japan. The digital platform sets out to connect Japan’s high-net-worth investors and their advisers with alternative asset managers.

Key number 3GPs step up their presence in the country

A flurry of team buildouts and office openings suggests that fund managers are optimistic about private equity’s prospects in Japan. At the end of 2022, for instance, Northleaf Capital Partners established an office in Tokyo, its second in Asia-Pacific. Jeff Pentland, a managing director and head of Asia-Pacific at the firm, told Buyouts that its aim was to create “a more immediate and local connection” with new and existing LPs in the region.

In early 2023, Investcorp followed suit. In a statement, the firm said that its new Tokyo office would allow it to “provide global alternative investment solutions in Japan, in addition to setting the grounds for Investcorp direct private equity and real estate investing in the highly attractive Japanese market”.

These openings have come alongside some high-level appointments in the region, including Apollo Global Management’s announcement that Tatsuo Tanaka, previously chairman of Citigroup Japan, would take on the role of Japan chair, and Partners Group’s naming of former Apollo executive Teppei Kawai as country head. In a statement at the time of his appointment, Kawai said the Japanese market was at “an inflection point”.