In a turn of events few would have expected at the start of last year, Asia-Pacific can be said to have had a comparatively quiet 2022 relative to its Western peers.

Some markets in the region resisted the urge to hike interest rates as steeply as those in Europe and the US, while China – for most of the year, anyway – remained largely isolated under its zero-covid policy. Though the latter is now emerging from these restrictions at breakneck speed, three years of limited travel on top of existing geopolitical tensions will continue to shape Chinese private equity.

Diminished appetites for the region’s largest private equity market contributed to a reduction in demand for Asia-Pacific more broadly last year. Funds in the region had raised $71.8 billion as of mid-December, substantially lower than the $103.9 billion collected for the whole of 2021, according to Private Equity International data.

Capital also became substantially more concentrated. The average Asia-Pacific fund had closed on $357.2 million as of December, compared with just $223.5 million the prior year; only 201 funds had reached a final close, less than half the 457 recorded in 2021.

“In China, funds were raising and deploying capital almost instantaneously – within 12 to 18 months – in the past few years, when the typical cycle used to be three to four years,” said Judy Zhang, managing director at Cambridge Associates. “But now, transaction activity has slowed, because investors are reassessing business fundamentals and the fund managers are taking longer to conduct due diligence on deals and on investment decision-making.”

With less fresh capital to deploy and fewer funds raised in 2022, the stage also looks set for a somewhat muted 2023. Here’s how Asia-Pacific private equity markets could play out this year.

Zombification ahead

Though in the process of reopening, China’s fundraising market is likely to remain challenging in 2023, according to Ricardo Felix, partner and head of Asia-Pacific at placement firm Asante Capital.

“[An] important factor will be the significant backlog of managers who wanted to avoid launching during 2022 now in need of dry powder, as well as several protracted fundraisers requesting extensions, which will further add to the increasingly asymmetric Chinese fundraising landscape,” he noted.

“A reduced universe of available LP dollars is being targeted by more GPs in the market than usual, resulting in the bifurcation we’ve witnessed [in 2022]: a concentrated minority of players becoming even larger, while a significant majority [are] not achieving their targets within their stipulated timeframes.”

One consequence of this slowdown could be that some GPs are simply unable to raise another vehicle. Left to run down their existing portfolio, these firms are sometimes referred to as ‘zombie funds’.

“That would not surprise me, if we would see more [zombie funds],” said Alvin Tay, chief portfolio adviser for Asia at Mercer. “I think the current stresses in the fundraising environment will eventually have to lead to some of that taking place. So I think that ultimately the question is how fast investor or LP attitudes towards China and the region generally is going to improve.”

Geographic diversification

Ongoing fundraising challenges in China may continue to diminish the appeal of pan-regional vehicles, many of which have traditionally deployed at least a substantial minority of their capital into that market. Managers of such vehicles – and their potential LPs – may therefore prioritise geographic diversification when returning to market.

“China exposure and economics are the biggest consideration in new funds,” one private equity fund formation lawyer said during a recent client webinar. “Some investors want a vehicle’s geographic allocations hotwired into fund documents.”

Markets such as India and Southeast Asia may stand to benefit. “What we’ve observed with pan-Asian funds is exposure to China is being reduced… and they are seeking to invest more of the capital outside of China,” added Tay. “And this capital has been going to markets like India and Southeast Asia, where we’ve seen a lot in the headlines, but we’ve also seen capital within these pan-Asian funds flow through to markets like Japan, Korea and Australia.”

Flexible fundraising

A tougher fundraising environment might also prompt Asia-Pacific fundraisers to get creative with their processes this year. This could include incorporating a longer pre-marketing or investor incubation period to give the GP more time to identify potential LPs that would be suitable to approach, Asante’s Felix said.

“We anticipate certain investor bases will also benefit from pre-emptive substitution tactics,” he added.

“For example, where re-ups from a certain geography or LP type are at risk – we’ve seen cases where over 70 percent of the existing LP base declined to re-up due to external non-GP-related factors – adjusting focus towards regions such as Southeast Asia and the Middle East, or the family office and Asia-headquartered asset manager and corporate arena, where the sentiment towards China has generally remained steady.”

Regional rebound

Given China’s effective closure last year, it’s unsurprising that deal activity in the region was comparatively muted. Asia-Pacific buyout values decreased 60 percent in the first three quarters of 2022 when compared with the equivalent period the previous year, according to Dechert. This was a steeper decline than the 45 percent drop recorded globally.

There were, however, bright spots. Japan recorded $19.9 billion of private equity buyouts in Q1 through Q3 last year – more than the entirety of 2021, which totalled $16.5 billion, per Dechert. Demand was likely catalysed by a weaker yen, as PEI explored in October.

Andrew Crook, an M&A partner and head of corporate for APAC at law firm Clifford Chance, expects a rise in private equity activity across certain jurisdictions and sectors in the region this year.

“This uptick will be the consequence of a number of factors, including China’s removal of covid restrictions and the resulting uptick in Chinese economic activity; the potential loosening of credit markets as global inflation begins to reduce; and the pent-up demand for PE investment,” he said.

“While difficult to predict, speaking with clients, it feels like South Korea, Japan, India and Thailand will see a material increase in PE investments. Australia will continue to be busy and China will slowly come back up the curve, initially driven by historically Chinese-focused GPs.”

Whether this rebound extends to exit activity is less certain. “GPs with mature assets to sell may delay exits given volatile markets pressured by uncertainty,” Cambridge’s Zhang noted. “Investors should expect longer holds, and perhaps more GP-sponsored secondary continuation vehicles.”