Japan's land of the rising fund

We’re only halfway through the year, yet barely a month has passed without news that a Japanese mid-market GP has closed its latest fund – most of them smashing targets and securing commitments from new, foreign LPs.

In the last week of April alone, Polaris Capital, J-STAR and Advantage Partners held final closes for their latest buyout vehicles on a combined ¥168 billion ($1.5 billion; €1.4 billion). These followed successful first or final closings for Integral Group, Tokio Marine Capital, CITIC Capital and The Longreach Group, all of which will invest in Japan. Private Equity International also learned Tokyo-based small-cap private equity firm DRC Capital is gearing up to raise a fund almost five times larger than its ¥15 billion predecessor.

According to PEI data, Japan-focused private equity funds have raised $2.2 billion in the first four months of 2017, dwarfing 2016’s total of $250 million and 2015’s $2.1 billion. Private equity and venture capital-backed deals rose from 364 in 2015 to 423 in 2016, according to S&P Global Market Intelligence.

Japanese funds have also performed strongly relative to their regional peers. Data from Eaton Market Research show that 2011- to 2015-vintage funds delivered, on average, a 1.8x return and 21 percent IRR, compared with China (1.5x; 21 percent IRR), India (1.5x; 15 percent IRR), and South-East Asia (1.4x; 16 percent IRR).

“This is the new normal in Japan and the reason why foreign LPs are coming back not just for middle market players but also to look at regional funds that invest actively in the country,” says Jun Tsusaka, founder of Tokyo-based mid-market firm Nippon Sangyo Suishin Kiko.

“The term ‘Japan passing’ [used to] be very common, which means people would just fly over Japan on their way to Beijing, Hong Kong or Singapore. Today people are stopping by Japan not just for sakura and sushi, but because they believe this may be an inflection point for alternative investments in Asia.”

Historically, Japan’s LP community was composed of banks, corporate pensions, life insurance companies and financial institutions. That universe has expanded in the last two years to include notoriously conservative government pension funds such as the $1.3 trillion Government Pension Investment Fund and aggressive regional banks seeking higher-yielding assets, a Tokyo-based fund of funds manager says.

The six mid-market funds closed so far in 2017 saw an increase in the percentage of non-Japanese LP commitments. Advantage Partners’ international LPs include European insurers and Asia-based funds of funds whose capital is drawn from US-based pension funds and family offices. Meanwhile, J-STAR’s third fund saw re-ups from existing foreign LPs, including global family offices and Australian superannuation funds.

Japanese GPs are not worried there may be too much capital chasing deals. Small and mid-cap buyout deals are plentiful, says Tokio Marine president Koji Sasaki, especially in business succession and corporate carve-out situations. Japan boasts a large pool of small and medium-sized enterprises (about 3.8 million) that make up more than 99 percent of its $5 trillion economy. The country’s ageing population goes hand in hand with succession-led transactions.

However, one Hong Kong-based private equity practitioner wonders whether the enthusiasm for Japanese private equity can be sustained or whether this is “as good as it gets”.
Niklas Amundsson, managing director of placement firm Monument Group, also warns of vintage risk, which could impact pricing. “Over the next cycle we will be able to identify the winners and losers; we’ll see who’s been disciplined in terms of doing deals and who’s been panicking,” he says.