Private Equity International caught up with John Haggerty, director of private markets investments for Meketa Investment Group, for his take on how the US public pension funds are allocating capital to Asia and the opportunities as well as challenges of investing in the region.
Meketa consults on more than $600 billion in assets for over 160 clients that include US public pension funds, university endowments and foundations, as well as high net worth investors.
What role does Asia play in a US pension fund’s portfolio?
Generally, allocations to Asia are smaller than the proportion that Asia represents in the global private equity market. A pension fund may take a market-weighted approach to structuring its portfolio, reference the proportion that Asia represents, in terms of fundraising dollars or of transaction volume, and set that as a guide for its exposure to Asia.
While these market measures will vary year-to-year, many pension funds have used them as a rough guide to set long-term targets to Asia; generally, in the five to 10 percent range. These targets may grow as there is wide recognition of the size and relevance of the Chinese market. However, there are some challenges that US pension funds face in achieving these allocations.
What are some of these challenges?
Apart from setting objectives for the allocation to Asia, on top of mind are the logistics of the due diligence for US pensions. The physical separation in time zones makes it harder to gain reputational and personal familiarity with managers in Asia. Another consideration for some clients is the expense of conducting diligence in the region. A third logistics challenge is the language barrier. While many research meetings and calls are conducted in English, a number of them require fluency in the local language, particularly reference calls.
As an advisor in the allocation stage, we are also sometimes reminded by decision-makers that historically China hasn’t been friendly to capitalism and this may still represent a risk for investors. While the system in China still operates differently from that in Europe and North America, today we can show ample evidence of strong realised returns and fair treatment of foreign capital. Still, I feel that it will take some time for the perception of these markets to catch up with the reality of today, which is a state of robustness and general support for business.
What is a typical path for a US pension fund starting a private equity programme in Asia?
When we sit down with our clients, we first ask them: ‘What do we expect to get out of Asia in terms of returns and diversification – and why?’ As we have already discussed, we also spend time defining which markets are most important. However, a very close second discussion is in regard to execution. We ask: ‘How do we plan to get this exposure? How many individual fund commitments will be made over the next three to five years? With how many managers do we seek to partner? Do we seek pan-regional strategies, country-specific strategies, or both?’
For some of our smaller clients, the best solution is sometimes a fund of funds [structure] focused on the region, in spite its higher cost and lower flexibility. Ideally, this fund of funds structure would offer a diversified portfolio, access to top tier managers and smaller underlying funds, as well as the potential for investor education and network building for future commitment that the investor may seek to make directly.
How are institutional investors responding to the challenge of deploying meaningful capital to the asset class?
Broadly speaking, US pension funds, especially the larger public funds, are grappling with the challenge of deploying capital at scale. Institutions with private equity programmes that are committing billions of dollars per year to the asset class need not only to work hard on finding quality investments, but also to work hard on identifying partners that can meet their capital deployment needs.
The closed-end fund format, which has been used by the largest pension funds for over 20 years, is now showing its limitations. Many investors are looking to create deeper partnerships with managers – in particular, with the larger global firms that may have multiple strategies. These partnerships will be aimed at getting reduced fees and greater transparency and market intelligence, in return for the investor making more long-term commitments of capital. Some of these partnerships will also involve an investor participating in multiple strategies offered by a manager, from private equity to debt to real estate. Additionally, they may involve tailored separately-managed accounts, co-investment programmes, and commitments to so-called ‘core’ private equity strategies that are designed for a longer time horizon and lower risk posture.
What are some of the most attractive investment markets in Asia?
China naturally dominates investors’ thoughts of investment opportunities in Asia, because of its size, population and growing influence. Other markets in which our clients are active are South Korea, Japan and India.
Investors often consider India a distinct opportunity set, influenced by a distinct business climate, culture, and political system. The nature of private equity opportunities there is dictated by the different sectors in which India is dominant, the inherent entrepreneurism in the business community and the local regard for the private equity industry, which has achieved fairly low penetration as of yet. Clearly, there is not a homogenous stretch of cultures and business climate from India to eastern China. As with China, India presents an opportunity for investors to benefit from a large population increasing its standard of living – and the consumption associated with that. A number of investors have also been attracted by the reforms proposed by Modi, but these have come slower than expected. Perhaps, the biggest challenge to deploying capital in India has been identifying general partners. There is a smaller number of groups that can demonstrate a long-term track record of success – particularly with control transactions. Managers have had to be nimble and opportunistic in order to make money in the highly dynamic private equity market in India.
Are the risks presented by the US-China trade war coming up in your conversations with US pensions?
Indeed. I think most large sophisticated pension funds would consider a trade war to be in their top 10 macroeconomic risks under consideration today. We have already seen an impact on certain businesses in the US. It is difficult to predict where the current trade dispute will go, but few see it as a positive for the global business climate. In my opinion, neither country will ‘win’ a trade war and it is possible that investments in Asia may benefit more from what will transpire.
John Haggerty is managing principal and director of private markets investments for Meketa Investment Group. He also chairs the firm’s Private Markets Investment Committee, which has resulted in over $1 billion in annual client commitments.