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10 May, 2017
In Asia, country-focused funds continue to outnumber pan-Asia private equity style fund raisings by a significant margin, illustrating the unique characteristics, challenges and opportunities represented by Asia markets for both country-focused and pan-Asia fund raising strategies.
The dominance of country-focused funds
In Asia, country-focused funds continue to outnumber pan-Asia private equity style fund raisings by a significant margin, in contrast to Europe where the opposite is true. This article considers why country-focused funds continue to predominate over pan-Asia funds and points to the obvious but often underappreciated diversity of Asian markets as a key factor.
Asia and Europe – The differing significance of 2:1
Over the past decade the number of single country Asia-focused fund raisings, on which the Ashurst funds practice has worked, vastly outnumbers pan-Asia funds. The exceptions have been notable, but few. A stroll through Preqin’s databases confirms that our firm’s experience is representative of a broader trend in Asia markets. Of the approximately 776 pooled funds established since 2014 having their main geographic focus in Asia (of all sizes and across all strategies, asset classes and industries), slightly more than two-thirds were single country-focused. For every two country-specific funds raised in Asia there is approximately one pan-Asia fund.
In contrast, a survey of funds raised over the same period in Europe (again, of all sizes and across all strategies, asset classes and industries) reveals the reverse trend. Some 1,361 funds were raised during that period, of which two-thirds were pan-European funds according to Preqin data. Thus, for every two pan-Europe funds in Europe there is approximately one country-specific fund raised.
It is worthwhile to try and account for this mirror difference in results between the two continents, as doing so reveals something of the unique characteristics, challenges and opportunities represented by Asia markets for both country-focused and pan-Asia funds.
Asia – Not one but many (heterogeneous) markets
It seems an obvious observation to make that Asia is not a single, uniform market. Yet the significance of this to fund raising activity in Asia cannot be understated; and nor should it be underestimated.
Whereas modern-day Europe is the product of years of economic and political integration that can be (formally) traced to the establishment in 1957 of the European Economic Community under the Rome Treaties, its closest parallel in Asia, the Association of South East Asian Nations (ASEAN) was founded in 1967 principally as a security-orientated rather than a trade-promoting organisation.
Although the EU's genesis is necessarily understood against the backdrop of the security, and existential, threat to Europe’s existence represented by two World Wars and their aftermath in the first half of the Twentieth Century, 60 years of political, economic and monetary integration in Europe have (at least until recently) helped allay those concerns. In contrast, ASEAN’s mandate has not been to strive towards the deep integration that the EU has embraced as a customs union with a common trade policy. Moreover, ASEAN’s membership does not include China and India, the two biggest markets and most populous nations in Asia. Consequently, Asia, unlike the European common market, remains fragmented and diverse – far less homogenous than the EU – and cannot be understood as one, but remains many heterogeneous markets and political economies.
To be certain, there are other factors that distinguish Asian and European markets, including Europe being a more mature market in counter-distinction to most parts of Asia, excluding Japan, which being in the developing world and with their comparatively youthful demographics offers more potential for growth. Nevertheless, these factors only partly explain the predominance of country-focused funds in Asia and diversity remains the principal distinguishing feature for reasons that we will explore in greater detail below.
Asia's diversity – Implications for country-specific and pan-country fund raising strategies
The diversity that characterises Asia’s markets raises a practical challenge for sponsors wishing to pursue pan-country fund strategies. The lower levels of risk that can be seen to attend a portfolio diversified across several markets is a key argument in favour of raising a pan-country fund. On the other hand, the successful sourcing and execution of the acquisition and divestiture of investments across more than a single country requires a commensurately greater commitment of time, money and personnel resources, including, importantly, resources on the ground. While this observation is universally true (including in the comparatively more homogenous European common market and its environs), the challenge is exacerbated in Asia precisely because of Asia’s greater heterogeneity.
Significant investments of time and money are required to acquire local commercial market knowledge in Asia across more greatly fragmented markets, whether on a green or brown-field basis. Similarly, the pursuit of investments requires an understanding of the legal, regulatory and tax features of diverse target markets, often varying significantly from country to country. The challenge is further magnified when one considers other characteristics common of many Asia markets: the generally smaller size of their economies and less diversification within them (though not without exception, China and India being notable examples), relatively illiquid capital markets and the prevalence of shareholding structures concentrated in closely held family and corporate groups, which provide more limited entry points and exit options than in more mature developed markets.
Smaller fund sizes too are both reflective of Asia markets as well as symptomatic of the challenges Asia funds face, as it is more difficult to achieve the economies of scale represented by the ideal of raising a large amount of capital for deployment in a small number of investments in a uniform market. Although such an ideal is likely nowhere achievable (it is, after all, an ideal), in Asia, with few exceptions, markets’ greater diversity means that it is generally necessary to spread fewer resources farther or invest greater resources than in more homogenous markets in an effort to acquire the local market knowledge and deal execution expertise upon which establishing a successful track record depends. A third option is simply to focus on fewer countries or a single market. Not surprisingly, particularly given the greater number of smaller and first time fund managers again characteristic of growth/developing markets and the correspondingly smaller private fund sizes raised in Asia, a balance between these competing priorities can often only be obtained by focusing on a single country, in-depth market knowledge about which a particular sponsor may have acquired painstakingly over a number of years.
The challenges outlined above are not lost on either sponsors of or investors in Asia-focused pooled funds. There is a general awareness that adequate depth and breadth of relevant market specific expertise and experience is required of sponsors across levels of their organisation. This includes market-specific expertise and experience at the deal team level, which suggests more than one individual, certainly, and likely also more than one team, each focused on its relevant market, with attendant implications for costs.
But market-specific experience and expertise is also required within the management team and, importantly, at the investment committee level. An investment committee that has not been adequately briefed, or that is otherwise insufficiently knowledgeable of a particular local market, may not fully appreciate the subtle and not so subtle differences between markets.
The challenges of operating in Asia local markets include having to recalibrate one’s understanding of risk/return trade-offs and many others that local deal and management teams will be well aware of.
This disconnect can manifest itself in two equally unsatisfactory ways: (i) overly conservative investment committee decisions resulting in a dearth of approved deal flow and frustrated deal teams on the ground; or (ii) with the investment committee relying too heavily upon the “on-the-ground” team, unknowingly throwing caution to the wind and taking on too much risk. The balance can be difficult to attain in particular for non-mainstream or “niche” markets. Against this backdrop, the predominance of single country-focused funds in Asia can again be better understood.
Duplicating roles among individuals or teams to focus on different markets can seem like an exercise in creating redundancy, but the point is to ensure that the market-specific knowledge and expertise required effectively to execute and establish a track record across markets that vary greatly is achieved. There is no substitute for local market knowledge in markets characterised by their great diversity and that axiom holds equally true for both country-specific and pan-country funds. Until Asian markets attain a greater degree of homogeneity characteristic of European ones, the greater resources required by pan-Asia funds to attain the required institutional critical mass suggests that one should expect country-focused funds to continue to predominate over pan-country funds in Asia.
Insights
Asia markets, being more diverse and less homogenous than the European common market, pose higher entrance barriers for raising pan-Asian funds than comparable pan-Europe fundraising.
Higher entrance barriers have resulted in Asia markets being predominated by country-specific funds.
Country-focused funds require a lower level of internal resources to manage but portfolios are of consequence less diversified
across markets.
Opportunities exist for both single-country and pan-country strategies in Asia if properly considered and executed.
For further information, please contact:
Dean Moroz, Ashurst
dean.moroz@ashurst.com
