Compared to your peers, SCM used to be bearish on Asia-Pacific. Have you changed your view?
Our fundamental issue historically has been that we price the competence and capability of management teams above anything else. Taking team risk in an emerging market such as Asia-Pacific is especially tough, because teams are by definition younger.
So what is different now?
Now the region is getting more mature, there are more proven managers around, and we have become more open as a result. Also, Asia-Pacific is taking a greater share of global private equity transaction value, which makes it more attractive too. We probably still won't be seed investors in a new team, but you do need to build the relationships that will allow you to get into Fund 2 or 3 before it's too late and they won't take your money. We're building these relationships right now, clocking up air miles across Asia and using the resources of our Hong Kong office. It's a lot of work, but we are bullish.
In researching the region this time around, was there anything that surprised you?
Some things scared me. Investors need to be cognisant that the private equity fabric in Asia remains completely different from other regions. For example, growth capital investment is extremely closely linked to IPO exits and thus reliant on a positive stock market environment – which means at the moment, after the massive stock market falls of the past 12 months, growth capital exits are almost dead.
In fact, financial markets have always been the region's Achilles heel: less liquid, more cyclical, and much more prone to sickness and fatal disease. This is why relying on IPO windows is much more risky there than in Europe and US. As LPs, we need to be cautious about this, and we need to be cautious about GP track records that cannot demonstrate genuine value being added other than mere participation in the last stock market bonanza.
How do you see the buyout market in the region developing?
Last year's activity went down relative to 08 – in Australia for example because the market was over-endowed with private equity capital, in Japan because the country's private equity penetration, given the size of the economy, is still microscopic. But we think Asia is a potential paradise for buyouts, especially now that capital markets are shut and equity capital to finance growth is still needed. To entrepreneurs, the appeal of the buyout concept today is as great as it has ever been, and activity is very likely to pick up once the current gap on price expectations between vendors and buyers starts to level out.
You're less positive about venture in the region…
We're hyper-scared of venture in the region! We practically do nothing there. The reason is a galactic mismatch between capital raised and capital deployed, by a factor of 6 to 10 times, and I don't believe for a second that markets in Asia-Pacific will grow fast enough to absorb all the money that's been raised. It's the kind of story that Silicon Valley venture capitalists who lived through the tech bubble should be very familiar with.
Is your allocation to China gaining in weight?
Yes. We believe China will produce a huge opportunity, and I wouldn't have said this 12 months ago. The whole economy is beginning to operate very differently. Because of the falling dollar and strengthening renminbi, combined with the international economic slowdown, exports are beginning to weaken, while at the same time the secular trend of falling production costs has reached its bottom: Chinese companies are already at the point where they can't produce any cheaper, and this has big implications. Chinese companies have been saying for some time that they want to climb up the value chain, but now this is no longer optional. It's a question of survival, which will provide good GPs with great opportunities to do what good GPs are good at – transforming businesses.