Asian secondaries: worth a second look

Asia’s secondaries market is coming of age in more ways than one, with growing structural sophistication and a host of opportunities for proactive players in the space.

The region’s current supply generally involves funds with vintages between 2007 and 2012, which are rapidly approaching maturity. Commitments in these funds are larger in size than those commitments made in the pre-2007 era, and are more diverse both in terms of geography and fund manager type. Once seen as coming from esoteric managers or large Pan-Asia funds and few in between, they now comprise a vast array of country-focused fund secondaries opportunities, particularly in the mid-market space.

For market participants, this requires a nuanced understanding of the six private equity market-relevant economies: China, India, South-East Asia, Australia, Japan and South Korea – and an appreciation for each opportunity independently.

The skillset of a secondaries buyer now leans more towards capturing information asymmetry and creating information advantage. Gone are the days of deep discounts to lock in profit on day one. We are seeing transactions in Asia range between a premium to NAV of 5 percent to discounts in the high teens, with very little transacting outside of this band. Today it’s all about buying well – which in practice is extremely difficult to execute.

In Asia, having some degree of geographical and sectorial expertise is therefore a determinant factor towards how successful an operator can be. A range of variables – regulatory volatility, exchange listing rule changes, accounting policy differences, valuation discrepancies or poor GP reporting quality, to name a few – mean investors in Asian secondaries need to be savvier than their western counterparts. Some see these as risks, while others see them as opportunities; it’s a double-edged sword.

In Japan, different accounting principles can be a challenge. J-GAAP can make it difficult for GPs to mark-up valuations unless a completed M&A valuation or up-round event occurs, and dual-currency vehicles may find valuation differences between a yen-denominated fund with J-GAAP accounting versus its US dollar-denominated counterpart of the same fund series. Secondaries buyers need to go the extra mile during diligence to ascertain true value, but this could mean that having local currency capability allows investors to take advantage of special situations.

Another regulatory challenge has surfaced this year in China, where listing rules have capped public sale of stock by an investor at a maximum percentage of not more than 12 percent per annum. Secondaries buyers need to be attuned to sudden regulatory changes like this that can drastically change the outcome of pricing exit expectations overnight, particularly deals in process.

As Asian banks’ and managers’ appetite for global private equity grows, many sellers are selectively liquidating a portion of their maturing portfolio in order to re-deploy this capital to take part in a new wave of global private equity or venture capital commitments. Partial exposures are thus becoming more common as investors seek liquidity to dip their toe from one pool to another.

In Australia, we are seeing asset managers and superannuations consider selling their private equity exposures on an opportunistic basis. This comes amid the country’s regulatory requirement to report management expense ratios, encompassing management fees across all asset classes paid to underlying fund managers. Since commitments to private equity managers drive up average reported MERs considerably, there has been intense competition and pressure among asset managers to lower MERs for other products such as fixed income. As such, MERs have been a driver of secondaries selling in Australia for some time.

This year, we are seeing a refocus on opportunistic selling that takes advantage of the current seller’s markets in secondaries. Atlantic-Pacific worked on a transaction to assist an Australian asset manager re-balance its portfolio via secondaries this year.

Having been active in Asian secondaries over the last decade, at Atlantic-Pacific we have seen structures become increasingly creative and sophisticated; secondaries players have become more proactive in gaining sectorial or geographical advantages. In this year alone, Atlantic-Pacific has represented Asian sellers aggregating over $600 million in NAV. As investors’ primary allocation to Asia now typically targets 20 percent – up from the 5-10 percent that used to be the norm – secondaries will continue to become a staple of the private equity landscape, and are poised to grow two to threefold over the next decade.

Charles Wan is a principal at Atlantic-Pacific responsible for deal origination, execution and product distribution across Asia. He leads the Asia office’s origination and due diligence activities relating to its primary capital raising and secondary transactions in the region and has prior experience at Pomona Capital in Hong Kong.