Why Asian secondaries have not yet delivered

Asia Growth Capital Advisors’s executive chairman and founding partner Harjit Bhatia explains why limited partners need to be pushier for Asian secondaries to live up to expectations.

What sorts of challenges have you seen in Asian private equity funds this year?

There has been a lack of exit opportunities, as during the last few years the capital markets have been shut down. India and China have both had different reasons. We have now reached a stage where there is anything between $250 billion to $300 billion stuck in unrealised value of investments made since 2005.

Currencies have also depreciated. India, Indonesia and Malaysia have all seen their currencies depreciate against the US dollar, and that is causing even more impact because most of the funds are dollar-denominated funds. So we have a situation where a lot of funds are stuck with their positions, exits are not happening, fund lives are getting to closure, and therefore some of the LPs are getting restless.

Why hasn’t the Asian secondaries market developed as quickly as people expect?

LPs haven’t been pushy enough, especially in the primary funds. The market will get accelerated when LPs start asserting their rights and demanding liquidation. If that means a change of guard and bringing in new people to manage the assets, so be it. If it means selling certain assets at market-driven prices, so be it.

Unless LPs drive, the typical failed general partner has no incentive to accelerate the liquidation process. The GP team is not going to make carry nor do they know what to do next as they aren’t in a position to raise a new fund. As a result, there are plenty of these “orphan” funds, and somebody has to act as a catalyst.

Are there any signs the market will change?

In India, capital markets are opening up at least, and there could be some exits, but those exits will only be for very good companies. That market is very selective right now. There are a lot of other companies that need plenty of help and restructuring, and those are stuck. They’re going to take time, and there is a need for experienced direct secondaries fund managers to step in and provide solutions, both at the GP and portfolio company levels.

The Chinese capital market is still in limbo. South-east Asia is shut down. The Malaysian and Indonesian economies are going through tough times. The Indian economy is the only silver lining but we hope its growth and investor sentiment sustains. Currently, the Indian market seems to have a little wider window for exits.

How has volatility affected your ability to price portfolio stakes?

It depends upon the level of volatility, both in public and currency markets. If the volatility is moderate (in the 5 to 6 percent range), it can be manged by factoring it into the pricing of the portfolio.

However, in cases of high volatility, in public or currency markets, there is a real danger of deals falling through.  For instance, we were looking at a portfolio in India a year and a half ago, which was triggered by a large institution wanting to sell off their assets due to a strategy shift. When we started underwriting the portfolio, the Indian rupee was around 53 to 54 to the dollar. By the time we finished the underwriting the rupee had depreciated to 62 to 63, and by the time we had to submit the binding bid, it was moving towards the 68-plus range. It became very difficult for both us and sellers to price the portfolio fairly.

What will it take for the negative sentiment around selling secondary stakes in Asia to change?

As more deals get done and there is a track record of secondaries fund managers making returns, this negative perception will go and a lot more people will become more comfortable with using the direct secondaries approach to provide liquidity solutions to GPs and LPs.

Additionally, Asian markets need to have more experienced and seasoned fund managers who have the skills and mindsets of taking over someone else’s portfolio and turning it around, working with the portfolio companies and making the requisite changes. Done well, returns on some of these portfolio acquisitions can be quite attractive, compared to pure primary deals, especially in the 2005 to 2008 vintages, where quite a few fund managers may find it difficult to make even an 8 percent hurdle rate. But to achieve that, fund managers focused on this space should be prepared to move away from the typical hunter mentality of not having ‘secondhand meat’. You have to take your ego away from deals and remember that you are there to make good returns for your investors.

Given the size of unrealised private equity investments in Asia and as more GPs and LPs start exploring liquidity options, more experienced direct secondaries fund managers will emerge in Asia and make the secondary markets grow many-fold in the next few years.