Why US pensions are tilting towards Asia

Strong macro fundamentals, a rising middle class and consumer and technology-driven developments are attracting pensions to the region.

US pension funds have been ramping up capital commitments in Asia amid high GDP growth rates and opportunities related to disruption and the region’s demographics.

In August, Teachers’ Retirement System of the State of Illinois revealed in its trustees meeting that it will focus on Asia next year as part of its private equity tactical plan. TRS Illinois also noted it would “re-evaluate its overall strategy within Asia to provide a clear path for future investments”.

San Francisco Employees’ Retirement System has also committed to the region, including making a $100 million capital commitment to Hong Kong-based and TMT-focused investment firm Hillhouse Capital Group, which has reportedly raised $10 billion for its fourth private equity fund.

California State Teachers’ Retirement System, the US’s second-largest pension fund, could double or triple its less than $2 billion exposure to Asia in the next three to five years, chief investment officer Christopher Ailman told Private Equity International in May.

Underlying reasons for the step-up in allocations include the region’s GDP growth rates of at least 6 percent, its rising middle class, and the growth opportunities and investment themes around disruption that are expected to generate outsized returns, LP sources said.

Art Wang, managing director, private markets at SFERS, said that while the pension’s long-term private equity returns have been strong – in the high teens and driven in large part by its venture capital portfolio – increasing valuations and competition in the US means it will be difficult to achieve the same level of performance. This is why the pension expanded its private equity programme into Asia in 2013, he added.

Leaving the backyard

“Historically, our VC returns were generated by US-focused investment partners,” Wang said. “We didn’t have to go outside of our own backyard, let alone the borders of the US. In the past five years, however, nearly 40 percent of our global private equity commitments have been to managers focused on the Asian region.”

SFERS has backed funds managed by Asia Alternatives, PAG and Long Hill Capital Management, according to PEI data.

A spokesman for TRS Illinois said the pension anticipates an increase in private equity commitments consistent with achieving its long-term allocation target of 15 percent. It held $6.5 billion in private equity investments globally as of 30 June, which is 12.7 percent of the total investment portfolio. The spokesman noted that Asia will be an important part of its private equity strategy in the future.

Some of the pensions are planting flags in the region, including Teacher Retirement System of Texas, which is mulling setting up an office in Singapore as it seeks better coverage of Asia and Australia. “We believe that having a local presence, rather than being 20-plus hours away by plane, will provide us with better regional coverage of Asia, India and Australia and puts us in a better position to build relationships and successfully compete for opportunities,” a spokeswoman for the $151 billion pension told PEI.

Investor sentiment around Asia, particularly China, was not always this positive. Wang said five years ago there was more scepticism about China, especially its leadership transition, shadow banking, ghost towns and a potential hard landing of its economy, among others.

“There are higher levels of risk – geopolitical, currency, regulatory, macro – and volatility when investing in emerging or less developed markets,” he said.

Ailman added CalSTRS has had mixed results in Asia and noted opportunities in China are plentiful even for lower risk investments due to the scale of the market. Due diligence and picking the right partners remain a challenge, he said.

­Co-investments and direct investment capabilities are other areas that the pensions want to grow in the region. “We’ve done some of both in targeted situations over the last five years, but certainly not in scale,” Wang pointed out. “We’re always looking for ways that we can become better and more responsive partners to our GPs.”

“More US institutional interest in Asia could also lead to a supply and demand imbalance and a capital overhang situation that’s more akin to the US or Western Europe,” Wang noted.

At the end of last year, dry powder for Asia-Pacific funds had risen to $225 billion, or 2.2 years of future supply at the current pace of investment, according to Bain & Company’s Asia-Pacific Private Equity Report 2018. This was up from $170 billion in 2016.