A closer look at PE penetration data

When it comes to pitchbooks, some data points are not as impressive as they look. The private equity penetration rate – a country’s GDP divided by total private equity investment – could be one such figure.

The penetration rate often appears in the marketing materials of emerging market funds, usually to suggest that a country is under-served by private equity. But, according to sources, it’s a misconception that the figure is actually a useful comparator between different countries – and it’s misleading to imply that a low rate necessarily represents an opportunity. 

“[The figure] could fit many purposes, depending on what argument you want to make,” says Jonathan English, director of Portfolio Advisors in Hong Kong.

Japan, for example, with a $6 trillion GDP, has the lowest private equity penetration rate among Asia’s major markets (see chart). Sources point out that while the number suggests Japan is under-served, this is actually due to a number of unique local limitations.

[The figure] could fit many purposes, depending on what argument you want to make

Jonathan English, director of Portfolio Advisors in Hong Kong



For instance, cultural factors often create barriers to transactions and narrow the playing field: a GP typically needs a long history in Japan to build a local reputation and access choice deals. Japan’s cultural resistance to change also matters: in the world’s third largest economy, large buyouts are rare. 

Likewise, India has unusual regulatory complexity, as well as layers of financial intermediaries between the GP and the target, which tends to limit acquisitions. 

Factors like these “make the PE penetration comparison across different markets irrelevant”, says Hao Zhou, manager at Bain & Company.

The figure is arguably more useful when comparing regions, because then, as Zhou puts it, “variances across individual markets will be normalised”.

“We’ve used it in the past in our own marketing materials as a regional figure for Asia to compare to the US or Western Europe over a long period of time to show relative industry maturity,” adds English. “But we don’t take it a step further than that.”

If the penetration rate is a misleading metric,what would be a better one? The dry powder index – the amount of funds raised minus the amount invested – is a more useful indicator for investment attractiveness in a market, adds Wen Tan, partner at FLAG Squadron Asia. It’s important because “an excess supply of capital over demand will create an issue for returns”.

Yet the index has its own drawbacks as a gauge for individual markets. Calculating the percentage of a regional fund that will be invested in a specific country is often guesswork; regional funds’ advantage is moving capital across markets to find opportunity. Of course, it’s possible to calculate a dry powder index based on country funds. But in Asia, country managers are relatively uncommon, even in the big markets of China and India – and in developing Asia, they are very rare. 

Once again, a regional figure is probably more helpful (see chart).

So while pitchbook statistics may appear to support a country-specific investment thesis, at the end of the day it’s all about the calibre of the local fund manager, adds Tan. 

“PE is not a macro-asset class, it’s a manager-selection asset class. In that sense, the amount of private equity activity is not of primary relevance. It’s what returns you can get from a given manager that matters.”