Side Letter: Obliterating PE’s J-curve; Chinese PE’s SEA change; European LevFin tips

Arkansas' $10 billion public pension has made a bold and logical move in adding PE to its stable. Plus: why China's reopening could have implications for Southeast Asian PE markets and what you need to know about European leveraged finance. Here’s today's brief, for our valued subscribers only.

Just happened

Little Rock, Arkansas: home to PE’s newest entrant (Source: Getty)

Obliterating the J-curve
Why get in on the ground floor when you can jump straight to the party happening in the loft? That appears to be at least part of why one US public pension has decided to lean on secondaries with the implementation of its private equity programme. Arkansas Public Employees Retirement System staff last week approved moves to launch into the asset class and target 5 percent exposure of its total portfolio by the end of the decade, with a whopping 75 percent of the capital going to secondaries.

Secondaries will give Arkansas PERS “a combination of relatively instantly diversified exposures across vintage, asset class and sector, no J-curve, access to a cash-flowing assets and shorter duration”, a source familiar with the pension told our colleagues at Buyouts, who reviewed materials for the pension’s meeting here (registration required).

It isn’t clear whether Arkansas PERS will commit to secondaries funds or will acquire secondhand fund stakes – the latter being easier said than done in any meaningful way, as the pension would either need to outsource buying activity or build an internal team from scratch. Still, its plan appears to be a no-brainer: either option allows the pension exposure to private equity capital that’s already invested in underlying companies, as opposed to starting from scratch with blind-pool direct funds. And with pricing for secondhand fund stakes trending at a roughly 20 percent discount to net asset value last year, according to various intermediaries’ reports, Arkansas’s move could prove a prescient one indeed.

A SEA change for Chinese PE?
China’s reopening could have implications for PE markets beyond its borders. The country’s GPs have looked further afield in recent years, with Southeast Asia a favourite destination. Some have set up shop in Singapore as a base of operations for the region, enabling them to access both a wider set of investment opportunities, as well as the pools of APAC family office capital flooding the city-state. An international focus has also been seen as an additional selling point when appealing to overseas institutions whose appetites for China might have waned.

Now that China has reopened, will these China funds pack up shop in Singapore and turn their attention back to the mainland? This is a question Side Letter posed this morning on a Southeast Asia PE webinar hosted by global law firm Morrison & Foerster.

“I think there will be a bit of that, particularly for Chinese GPs who have historically only ever focused on China and are happy to continue doing that once China starts ramping up again,” partner Steven Tran said on the webinar. “But I think many of the drivers which put Southeast Asia firmly on to investors’ radars all remain valid and relevant notwithstanding that China is now open for business again. So I think most Chinese GPs who have expanded into Southeast Asia will continue to invest in the region going forward, as an adjunct to their core China focus, but also as part of a deliberate expansion of their investment strategy beyond China.”

The bottom line: investors who’ve committed to China funds during the pandemic may find themselves with what some will see as a bonus exposure to Southeast Asia’s burgeoning PE scene, whether it be in the form of portfolio companies headquartered in the region, or Chinese assets benefiting from access to a broader international network.

So, yuan to raise a China fund?
While we’re on the subject, Warburg Pincus is seeking 3 billion yuan ($435 million; €408 million) for its debut yuan-denominated fund, according to Reuters. This latest move seems to form part of a growing trend of international firms looking to capitalise on deglobalisation and diminished appetites from some international investors for Chinese PE. Consumer PE giant L Catterton also unveiled plans last year to raise a 2 billion-yuan fund, and Hamilton Lane this month launched a debut yuan secondaries strategy via the Qualified Foreign Limited Partner scheme.

Those considering dedicated yuan funds may have to adapt to slightly different expectations from China’s domestic LPs; local funds have been known to feature different terms than their peers, such as deal-by-deal waterfalls, large GP commitments and shorter fund lives.


Five tips for European leveraged finance

“Hitting the brakes” is how a report from law firm White & Case describes the European leveraged finance market in 2022, as leveraged loan issuance fell by 37 percent compared with the previous year and high-yield bond activity plummeted 66 percent. The report predicts five factors that will characterise the market this year:

1. Amend and extend: With refinancing off the table in many cases, borrowers with credits approaching maturity will look to amend and extend their existing debt tranches. Deals will typically offer lenders a consent fee and higher coupon in exchange for extending maturities by one to two years.

2. Mid-market deals to dominate: Inertia in the syndicated loan and high-yield bond markets makes it challenging for private equity firms to finance mega-deals. Still, mid-market M&A financing – mainly provided by direct lenders – remains available and will sustain mid-market deal volumes.

3. Secondary market will drive primary market: European leveraged loans were pricing at an 11 percent discount to face value in the secondary markets in September and October, compared with less than 2 percent at the start of the year. Until discounts narrow, the prospect of a revival in primary markets is slim as the secondary market will remain more attractive.

4. Restructurings loom: Amend and extend will only be made available for favoured deals, where there is a real prospect of portfolio companies returning to growth in the medium to long term. Distressed debt funds are raising pools of capital to buy up discounted debt.

5. Sponsors will hold the line on terms: There are no signs of a major change in terms and documentation as borrowers concede higher borrowing costs without a return to “old school” documentation. Covenant-lite structures and flexible terms are here to stay.

Today’s letter was prepared by Alex Lynn with Adam Le.

– This article was updated to reflect the correct target of L Catterton’s yuan-denominated fund, which is 2 billion yuan.