Is Asian private equity sustainable?

In interviews with Philip Bilden, Managing Director of HarbourVest Partners (Asia) and Andrew Lebus, Managing Director of Pantheon Capital (Asia), two leading advisors to global institutional investors, Kathleen Ng discussed the future prospects of Asian private equity.

(PB: Philip Bilden, AL: Andrew Lebus)

Do you think private equity is a sustainable investment model in Asia?
PB: The model is a sustainable one but the opportunity set is narrower than most people think. Selectivity is the key to success.

AL: The private equity model is sustainable when the supply of capital and expertise is in equilibrium. This is the case for the first time since 1990.

In your opinion, what have been the reasons behind Asian private equity's dismal returns?

PB: The asset class is still immature and evolving much like other developed markets in the U.S. or Europe had to evolve over longer periods of time. In addition, the poor macroeconomic environment, weak capital markets and misplaced optimism have had an impact on returns.

AL: Poor historical performance is explained by a number of factors. Macroeconomic and structural factors explain the poor performance of Asian financial markets since 1993. Over-rapid expansion of the private equity market led to undisciplined investment and investors are paying the price.

We have seen management buyouts at some funds, for example PAMA Group from Prudential and Transpac Capital from Development Bank of Singapore. What are your views on this trend?

PB: An established fund manager that has the support of its limited partners will benefit greatly from a management buyout. In addition to eliminating the ?economic tax? paid to the parent company, the manager has greater incentive to build its franchise to deliver maximum value to the limited and general partners.

AL: Limited partners will normally favour management ownership of the general partners. The franchise value of the general partner relates not only to its potential to generate investment performance for limited partners but also to its reputation as a fiduciary and responsiveness to and consistency of dealings with its various constituencies.

What are the realities facing those who have staged or are planning to pursue a management buyout?
PB: As long as the terms of the buyout are fair and include the interests of the limited partners, the general partner will be able to build a sustainable business. However, performance numbers will ultimately determine success.

AL: Ultimately, the ability to generate superior investment performance will determine a general partner's ability to raise capital. Provided that the terms of a management buyout reflect organizational values that are fully aligned with the interest of the limited partners, then it should strengthen the general partner.

What are your views on the China market?
PB: In the short to medium term China will continue to attract investment from multinationals with the requisite operational skills.

AL: The economic fundamentals may be alluring but private equity investors will not be the first to capitalise on these improving conditions.

So, what are the challenges for private equity investors going into China?
PB: Despite the optimism surrounding China's significant potential as a marketplace and its entry into the WTO, inadequate legal infrastructure, limited transparency, and contract enforcement difficulties make it challenging to conduct business in China.

AL: The difficulties of obtaining normal levels of legal protection, obtaining liquidity on exit and a different management culture. Investors will have to overcome some of the structural obstacles.

How can Asian private equity fund managers improve their investment returns?
PB: Asian private equity fund managers will continue to face challenges as the market for private equity transactions develops. However, high market inefficiencies also mean opportunities for attractive deals, although private equity investors have to be selective.

AL: Asia's relatively immature market infrastructure will continue to present private equity investors with difficulties but these can be managed and overcome by appropriately experienced general partners whose interests are aligned with their investors and whose commitment to the region is long term.

Kathleen Ng is editor and publisher of the Asia Private Equity Review in Hong Kong.