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Neuberger Berman: Japan’s institutional investors branch out

Japanese LPs are looking beyond commingled funds to more customised solutions, including fund of ones and SMAs, say Neuberger Berman’s Ryo Ohira, Jonathan Shofet and Yoshi Yagisawa.

This article is sponsored by Neuberger Berman.

Institutional investors in Japan have become increasingly active in PE, expanding into customised programmes to achieve individualised investment goals, diversified potential returns, and ESG targets. Neuberger Berman’s Ryo Ohira, head of East Asia, Jonathan Shofet, global head of private investment portfolios, and Yoshi Yagisawa, managing director, PE Japan coverage team, outline the trends they have been seeing.

How much have custom fund programmes grown within PE in Japan and what is driving that growth?

Ryo Ohira

Ryo Ohira: One of the most notable investment trends to emerge from Japan is the increased use of custom fund programmes to access private equity. Ten years ago, most of our clients’ assets in Japan were held in commingled funds, but today this accounts for less than half of our business. The largest percentage is in custom fund programmes and today NB Private Markets manages more than 30 unique custom account programmes in Japan.

We believe this evolution in Japanese investor demand for custom accounts is natural. It allows institutions to build bespoke portfolios in a diversified, cost-efficient manner and is generally viewed as a complement to commingled PE products.

Within Japan, we see this trend continuing and even potentially accelerating for investors who want three things: access to PE in a diversified and cost-efficient manner; greater customisation and governance over investments; and the implementation of specific back-office and reporting requirements.

How is creating and managing custom programmes different to commingled funds?

RO: Custom programmes and commingled funds are very different. Customised programmes can be tailored based on a variety of factors including by strategy, asset class and geography, and also by structure, jurisdiction or back-office and reporting requirements. This is different from commingled funds, which may have hundreds of LPs, which makes customisation for any one investor challenging. The creation of a customised programme demands significant collaboration between the investor and the fund manager, with both parties operating in an integrated and collaborative manner.

For us, building out our custom programme side has been a 10-plus-year investment in people, processes and systems. At the centre of this is our large team in Tokyo who work with our Japan clients to understand their unique needs and objectives. Today our Tokyo team stands at more than 100 institutional sales team and product specialists covering both the public and private sides of Neuberger. Having deep resources on the ground – speaking the local language – is essential.

Nearly 10 years ago we supplemented our efforts in Tokyo by establishing our PE Japan coverage team in our New York headquarters. This group is a part of our private markets investment team and is comprised of Japanese and Japanese-speaking professionals who work exclusively on custom account portfolio construction, programme management and client services for our Japanese investors.

Having both a large local and US-based Japan coverage team allows us to provide a rapid and comprehensive service to our Japan clients. Lastly, we continue to devote significant resources to technology and systems. That has been essential to allow us to grow and scale.

What challenges are LPs in Japan facing as they increase exposure to PE?

Jonathan Shofet

Jonathan Shofet: We believe the greatest challenge facing Japan’s LPs, and all LPs, is how to consistently select and access the best private equity investment opportunities in a cost-efficient manner. There are thousands of private equity funds operating around the world. It is difficult to determine which funds are best at their respective strategies without significant insights from a large and global team, which is resource-intensive to create and maintain.

That issue becomes even more challenging when moving from fund investing to co-investment and secondary investing. Likewise, we believe it is difficult to access the most desirable funds and deals in the marketplace without a pre-existing or otherwise deep relationship with the fund manager, and those relationships often take years to develop.

Another challenge for LPs globally is that investing in funds has become more complicated and labour intensive, post commitment. Historically, once the heavy lifting of a primary fund commitment had been made, investors would monitor the investment closely but did not have many decisions to make during the hold period.

That has changed with the rise of the GP-led secondaries market and associated LP re-investment and roll options, an increase in cross-fund transactions and the proliferation of manager strategies that may cause conflicts or the appearance of conflicts. Navigating this requires resources, specialised capabilities and strong GP relationships.

Lastly, Japanese investors often have unique reporting requirements that are not off-the-shelf for GPs and require effort to obtain. For Japanese investors, the solution to a number of these challenges is to work with a partner, often within a custom fund format.

The PE fundraising market is crowded this year. Does that present any opportunities for Japanese LPs?

JS: Yes, it does. Many funds are back to market more quickly than anticipated, and this has led to a relatively crowded market. At the same time, many LPs are experiencing both a numerator and denominator effect, due to a combination of strong private equity returns over the past few years and recent stock market volatility.

We believe that this dynamic has created a potential opportunity for LPs who have the capabilities, relationships and capital to be both extremely selective while driving allocations to highly sought-after funds.

Are you seeing increasing activity within ESG and impact investing from Japanese LPs?

RO: Japanese investors have been among the most sophisticated and forward-looking when it comes to ESG. They have helped to materially raise the bar in these areas, especially in integrating ESG into their investment process and in engaging GPs.

The financial institution community in Japan has been particularly focused on impact investing and climate transition issues, because many of them have made public net-zero commitments. These institutions are exploring a range of possible ways to monitor and reduce their portfolio emissions, including within their private equity and infrastructure portfolios. They are also exploring natural capital solutions, such as in forestry.

Outside of traditional buyout fund investing, what areas of interest are you hearing about from Japanese LPs?

Yoshi Yagisawa

Yoshi Yagisawa: Japanese LPs are pursuing complementary strategies to traditional buyout fund investing, as well as expanding into other areas within private markets. Within complementary strategies, there is a high level of interest in co-investments and secondaries.

Many Japanese investors have ample experience in primary fund investing and look to co-investments and secondaries to enhance potential returns, reduce costs, increase diversification and tactically allocate to select sectors. Due to the material resources and specialised capabilities this requires, many Japanese investors look to a partner to facilitate these activities.

In terms of expansion into other areas within private markets, we see increasing interest in growth equity and venture capital, private credit and infrastructure. Japanese institutions that have material buyout exposure are exploring growth equity and VC to diversify and augment their portfolios.

In part this interest has been driven by ongoing and covid-accelerated structural changes in the global economy, which emphasise technology; the fact that companies are typically staying private for longer; that certain owners of great businesses want a capital partner versus a sale of their company; and that there may be the possibility of more attractive valuations given the recent pullback in the public technology and growth sectors.

Private credit continues to proliferate within Japanese investors’ portfolios, driven by direct lending strategies, given the robust buyout market and increased needs of private debt financing. As market volatility persists, some Japanese investors are looking at structured equity and other capital solutions strategies in addition to distressed debt.

Lastly, infrastructure assets continue to attract Japanese investors, notably for energy transition and digital infrastructure businesses, in addition to more traditional core assets such as roads and bridges. While the vast majority of Japanese investors’ capital in infrastructure is still on a primary fund commitment basis, we are also seeing growing interest in fee-efficient co-investments and well-priced secondaries.

Is there growing demand for more ‘liquid’ PE alternatives?

RO: Yes, primarily within the pension space, we see growing demand for open-end private assets products, which provide limited liquidity within pre-specified timing windows. These funds can be structured as single-strategy vehicles or can span various asset classes such as PE, private credit, infrastructure, real estate and other strategies.

Typically, the institutions most interested in these vehicles are balancing the desire for the enhanced return potential and diversification that private markets asset classes can achieve, combined with greater liquidity than traditional vehicles offer.

As Japanese LPs become increasingly active in PE, what is your outlook for the asset class?

JS: The investing environment is as complex as it has ever been, with a combination of interrelated forces at work, including inflation, rising rates, labour tightness, geopolitical conflicts, global supply chain reconfiguration, rapid technological change, stock market and currency volatility, and the ongoing effects of the pandemic. However, operating and market challenges tend to create significant investment opportunities, and our outlook for the PE asset class is bright. The reason is that private equity is fundamentally about positioning companies for success.

For certain companies, that may mean material enhancements to the products and services being offered and the optimisation of operational expenses. For other companies, that may mean a deeper transformation involving the acquisition of complementary businesses, expanding operations globally and divesting non-core assets. This often entails enhancing management, recruiting talented workers and aligning employee incentives to new strategic goals. It also usually means rewiring workflows and embracing technology.

All of this is easier said than done, especially given the current environment. Private equity can typically provide the expertise, resources and capital to make these changes possible, and when that happens successfully, substantial value can be created for investors in the asset class.