A RE-EVALUATION OF RISK(2)

At the time of going to press, Bear Stearns had recently announced a further 300 job losses, bringing the total number of redundancies at the investment bank to 4,600 since the credit crunch struck. Job losses running into the hundreds or thousands had been announced in the same or preceding weeks by the likes of Credit Suisse, UBS, Lehman Brothers and Morgan Stanley. Some were not predicting the knock-on effects of the crunch to subside anytime soon. Credit Suisse said it expected sub-prime fallout to continue for another 18 months.

In the private equity firms [of the West], sentiment seemed to be improving a little. Estimates of when something approaching ‘business as usual’ would return in the larger buyout market initially ranged from a few months right up to the 18 months suggested by Credit Suisse. Recently, perhaps encouraged by the amount of capital being committed to funds designed to hoover up the excess credit, views seem to have been siding more towards the three-month end of the spectrum.

But whatever the timeframe during which the effects of the crunch continue to linger in Western markets, the situation in Asia is notably different. Here, private equity activity has not visibly diminished. Some of Asia's developed markets were hit by the failures of special purpose vehicles – notably, Singaporean bank DBS Group Holdings was forced to liquidate a conduit vehicle in August. Japan and Australia also experienced some problems of this nature. But in Asia's emerging markets, where, crucially, the private equity boom has not been fuelled by the use of leverage, the good times have continued to roll.

A glance at sister website PrivateEquityOnline.com reveals a region where there's been no shortage of significant new announcements: From a couple of A$1 billion-plus deals in Australia (DCA Agedcare and Coates Hire) to the launch of a $200 billion Chinese government fund; and from the bulking up of Carlyle Group's Southeast Asia team to the wrapping of a new $1.5 billion Asia-focused fund by Morgan Stanley.

Perceptions of Asian private equity's robustness are further confirmed by recent statistics from the Centre for Asia Private Equity Research showing that, by September, Asian funds had already raised almost as much capital as in the whole of the previous year. These figures confirm the extent to which Asia's potential continues to be recognised by limited partners.

Turn back the clock a decade and things were very different. For those who believe that the macro-economic risk of investing in Asia is inherently greater than investing in the West, the Asian financial crisis of 1997 represents the definitive illustration. The precise causes of that event, which had a “Great Depression”-like effect in countries such as Thailand and

Indonesia, are still the subject of intense debate. However, a view often expressed – including in a subsequent report by the Asian Development Bank – is that there were fundamental weaknesses in certain Asian economies that made them highly vulnerable once the Thai baht was devalued.

Whether this is the right interpretation or not – others point to irrational investor panic as the main trigger of the crisis – an unfortunate side-effect was that it confirmed to many investors what they had always suspected: Namely, that Asia carried greater macroeconomic risk than the West and that this should therefore be a vital consideration in any assessment of the region's risk/reward ratio.

Today an enduring legacy is that you still hear GPs and LPs alike, in spite of their growing enthusiasm for the region, frequently talking about the macro-economic risks associated with investing in Asia. In fact, the tables with the West have largely turned compared with ten years ago. Asia's debt to GDP ratio, a prime indicator of credit standing, is low compared with the US and Western Europe. Likewise, Asian current account deficits and budget deficits are on the whole very small compared with the huge fiscal imbalances in the West. On almost any measure you use, Asia appears less vulnerable to macro-economic shocks than the US and Europe.

There are reasons for being cautious a mid the hype surrounding Asian private equity. Those less enthusiastic about the region often cite micro-level factors such as the difficulty of identifying outstanding GPs and concerns about exiting investments easily. But for those whose main concerns are still based on Asia's ability to withstand exogenous shock, the credit crunch may have challenged a few assumptions.