Insight Article Desktop Banner
 
 
Insight Article
  •  
aprile 18, 2023

Why Invest in Asian Private Equity? The Case for Outperformance

Insight Video Mobile Banner
 
aprile 18, 2023

Why Invest in Asian Private Equity? The Case for Outperformance


Insight Article

Why Invest in Asian Private Equity? The Case for Outperformance

Share Icon

aprile 18, 2023

 
 

Amid current financial market volatility, investors are revisiting asset allocations in their portfolios, hoping to identify attractive market segments with upside potential. Morgan Stanley Investment Management (“MSIM”) views private equity in Asia as a potential bright spot for investors that offers the opportunity for outperformance, particularly at the current juncture. While Asian private equity can be a difficult segment to diligence and access, MSIM believes that its 20+ year history investing in private equity funds and opportunistic investments in Asia, combined with the broader resources of Morgan Stanley, can help bridge this knowledge gap.1 MSIM’s upcoming series on “Why Invest in Asia Private Equity?” will look to demystify the opportunity, starting out with “The Case for Outperformance,” which explores some of the drivers of outperformance including accelerated growth/leapfrog potential, valuation arbitrage, and the opportunity for company-level professionalization and efficiency improvement. In subsequent papers, the team will go into further depth on the region, covering topics such as the opportunity for venture capital in India and the current state of private equity in China.

 
 

Asian Private Equity: Where’s the Risk Premium?
Investors looking to Asia usually ask, “Can I expect a risk premium?” In short, yes—at least based on MSIM’s analysis. On the surface, historical private equity (“PE”) performance in Asia has been shown to be on par with performance numbers generated in other regions. However, top-performing Asian private equity funds show historical performance that often exceeds top-performing North American and European funds.2 This outperformance has generally been delivered with lower levels of underlying leverage, as company-level debt is less readily available and/or less attractively priced in Asia versus Western markets, and private equity subscription lines of credit are less commonly used by funds in Asia.3 General partners (“GPs”) in the region that are able to identify the right market opportunities and execute accordingly have shown that they can indeed deliver that much desired “risk premium”.

This paper covers a few of the drivers of outperformance in Asia—accelerated and leapfrog growth, valuation arbitrage and efficiency improvement—and why these observed characteristics make the Asian market particularly attractive.

 
 
Display 1
 
Private Equity & Venture Capital Net IRR from 2002-2017 by Primary Geographic Exposure
 

Source: Preqin Pro as of September 30, 2022

 
 
Display 2
 
Average Top Quartile Fund IRR from 2002-2017 by Primary Geographic Exposure
 

Source: Preqin Pro as of September 30, 2022

 
 

Accelerated Growth/Leapfrog Potential

COPYCAT MODELS ACCELERATING GROWTH
Unsurprisingly, growth is a leading factor that makes Asia an appealing target for private investment capital. Beyond robust GDP growth, under-penetration in many sectors creates opportunity for accelerated growth. The adoption of technology within China over the past two decades is a good example. In the early 2000s, China’s tech industry followed a copycat model, with consumers adopting technology that had proven successful in the U.S. This trajectory led to faster adoption; based on data from 1997-2015, ‘unicorn’ status Chinese Internet startups took an average of four years to reach their $1 billion valuation—versus seven years for their U.S. counterparts. Among this cohort, 46% of Chinese unicorns reached that status within two years—versus only 9% of U.S. unicorns, suggesting this hyper-accelerated growth as the ‘norm’ rather than the exception among successful Chinese startups.4

TECH AS A LEAPFROG OPPORTUNITY
In addition to the “copycat” model, Asian markets have demonstrated a “leapfrog” phenomenon—whereby one region replicates and rapidly improves upon an innovation witnessed elsewhere. For example, while China tech was initially a copycat play, China’s Internet sector has surpassed the U.S. in several areas (e.g., mobile payments, online shopping). Under-penetration of financial services and modern retail presented an opportunity for China to develop more advanced solutions than what existed in the West.

Beyond China (which is currently facing its own challenges), “leapfrog” potential exists in other parts of Asia. While emerging Asian countries generally lag in terms of adoption of traditional banking products (e.g., credit cards),5 consumers in emerging Asia over-index on adoption of fintech products.6 Knowledge gains from more established regions can serve as the foundation for even better solutions in more emerging Asian regions. In Indonesia, for example, stakeholders including entrepreneurs, venture capital (“VC”) funds and politicians, are working in concert to pre-empt potential fintech-related regulatory issues observed in the U.S. and China, such as crackdowns in the peer-to-peer lending space. This can lead to less friction as industries grow. Mobile solutions such as real-time online loans to the unbanked, leveraging digital information, cross-border transfers at lower friction/cost, etc., are all helping to boost financial inclusion in Southeast Asia. “Leapfrog” tech potentially has the ability to further accelerate growth, thereby offering the opportunity for outsized returns.

 
 
Display 3
 
Credit Card Penetration by Country, 2021
 

Note: Credit Card Penetration as defined by percentage of people age 15+ who use credit cards Source: Statista, data as of June 2022

 
 
Display 4
 
Digital Wallets as a Percentage of Total Payments, 2021
 

Source: PPRO Asia Pacific, Western and Central Europe, North America Payments and e-commerce report 2022

 
 

Accessing a Valuation Arbitrage

OPAQUE ENTRY VALUATIONS
While there is generally broad appreciation for growth potential in Asia, there is often an implicit assumption that markets are efficient with commensurate valuations, or, said differently, that higher growth potential means higher valuations.7 That is not necessarily the case in Asia. The complexity and idiosyncrasies of Asian markets usually result in greater opacity to valuations. Paired with lower valuations— public market valuations trading as much as 40-50% lower than the US on a P/E basis,8 and private markets valuations that have almost halved from their peak9— there should be a particularly attractive opportunity at hand.

IT’S NOT JUST THE PRICE
A defining characteristic of Asian markets is the way geopolitical and cultural factors inform how business is done. The Covid-19 pandemic re-emphasized the importance of localized operations, as closed borders made it impossible for non-local managers to undertake transactions. Beyond localized operations, the ability to adapt to unique customs can be both a hurdle and opportunity. For example, in Japan, deals are often won based on trust, not price, as sellers look for buyers who will preserve their legacy post-transaction. In India, where valuations are persistently high, GPs can structure a ‘win-win’ two-stage deal that involves an initial investment at a reasonable entry valuation, work alongside the entrepreneur to improve the operations and positioning of the company, and eventually exit together at a premium valuation. There are also pockets where capital supply/demand dynamics remain reasonable, resulting in attractive entry valuations—e.g., in Thailand, there is a paucity of PE managers facilitating investment opportunities in high quality, growing companies.

 
 
Display 5
 
MSCI Indices (January 2020- February 2023)
 

Source: S&P Capital IQ as of 28 February 2023.

 
 
Display 6
 
Private Market Valuations in Asia
 

Source: AVCJ Research, as of 31 December 2022. Private market valuation refers to round size, as determined by capital invested divided by no of deals.

 
 

SCARCITY VALUE DRIVES SIGNIFICANT EXIT PREMIUMS
Exits in the region are notoriously complicated, as tighter public markets limit IPO options and geopolitical uncertainty clouds valuations. Yet, high-quality assets in segments where there is perceived scarcity value can often achieve premium valuations at exit. An example of this are the shares of Indian banks and non-bank finance companies (“NBFCs”) where the highest quality banks/NBFCs trade at Price/Book multiples 3-7x that of the market median.10

Further, there is a local-global arbitrage opportunity—identifying a company at a well-priced local market entry valuation, repositioning the company for global markets, and exiting at a premium valuation commensurate with a global company. This has played out among Korean tech companies where early-stage investments are limited to local VCs, keeping valuations modest. Companies with cutting-edge tech and design can be positioned for Asia and/or global expansion and sold at a premium valuation. Similarly, Australian software companies can be invested in at modest high single-digit/low double-digit EV/ EBITDAs and sold on to global strategics at premium double-digit EV/EBITDAs.

By navigating unique cultural and geopolitical situations, arbitrage opportunities, and positioning companies well for exit, sophisticated GPs can capitalize on the inefficiencies of this market dynamic to “buy low, sell high.”

Professionalization and Efficiency Improvement – An Additional Source of Alpha

OPERATING EFFICIENCY – AN OVERLOOKED RETURN DRIVER
To date, top-line revenue growth has been the largest contributor to Asian PE returns.11 This is unsurprising, given that until recently growth has been easy to come by in Asian markets, making efficiency (and hence margin) improvement less of a focus. From a GP’s perspective, effecting operational change requires more effort and a specialized skill set, as well as significant influence on a company which is often lacking in minority stake deals (the predominant deal type in much of Asia). However, GPs who are willing and able to do the hard work have an additional lever to create value in companies and can potentially deliver alpha above their peers. As overall GDP growth slows, efficiency improvement will become increasingly more important.

ASIAN BUSINESSES – RIPE FOR PROFESSIONALIZATION
Many attributes of businesses located in Asia are well-suited to operational improvements that can both further growth and increase margins. In China, state-owned enterprises make up approximately 40% of GDP.12 These companies have traditionally been less nimble and commercially focused than their private counterparts, with many straightforward areas for operational improvement. In Asia overall, family businesses and small and medium enterprises make up 85- 90% of companies.13 Many of these businesses operate at low margins due to limited implementation of systems and technology. Anecdotally, as little as five years ago, many businesses in the region managed trucking logistics via paper on a clipboard. Automating these manual, inefficient processes are potential ‘easy-wins’ to improve efficiency. Going forward, shifting macroeconomic conditions will make efficiency initiatives an increasingly important value driver in Asian private equity.

Conclusion
Investing in Asian private equity comes with a unique set of challenges and risks beyond what this paper has explored. Geopolitical risks, currency risks, and exits/liquidity are important considerations for investors contemplating an allocation to Asian private equity, and adequately addressing these risks are undoubtedly key to achieving positive performance in Asian markets. MSIM will look to address these risks/opportunities in future briefs.

Notwithstanding these risks, a variety of factors—accelerated growth/leapfrog potential in underpenetrated industries, opaque and attractive valuations relative to developed markets, and overlooked opportunities for improvements in operational efficiency—contribute to the region’s potential for outperformance. The market environment in the next few years will present further dislocation and opportunity for fundamental value creation. Critical in this endeavor is the identification of private equity managers which possess the appropriate skills and requisite experience to manage the region’s unique challenges. For those that can identify and partner with such private equity managers, there exists a promising opportunity for outperformance in the region.

 
 

1 Subject to third party confidentiality obligations and internal policies and procedures established by Morgan Stanley, including information barriers and allocation policies, to manage potential and actual conflicts of interest and/or in respect of regulatory requirements.
2 Preqin, data as of September 2022. Vintage years beyond 2017 have been excluded as performance is less mature and may be too early to tell. Note that the data discussed here is limited to only what is reported to Preqin; as a result, the dataset may suffer from survivorship bias. Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown.
3 Preqin, data as of July 2022.
4 Source: BCG, “Decoding the Chinese Internet” Sept 2017
5 Source: Statista, data as of June 2022. Credit Card Penetration defined as percentage of people 15+ who use credit cards.
6 Source: PPRO Asia Pacific, Western and Central Europe, North America Payments and e-commerce report 2022.
7 An efficient market is one where the market price is an unbiased estimate of the true value of an investment.
8 Source: Bloomberg, data as of February 28, 2023.
9 Source: AVCJ, data as of September 30, 2022.
10 Morgan Stanley Research, “Investor Presentation – India Banks”, November 11, 2022.
11 Bain & Company, “Asia-Pacific Private Equity Report 2022”.
12 Weforum.org “How reform has made China’s state-owned enterprises stronger” October 2020.
13 Russell Reynolds, “Transitioning to the Next Generation: Leadership succession within family businesses in Southeast Asia”, November 2021.

 
pamela.fung
Executive Director,
Morgan Stanley Private Equity Solutions
 
 
Approfondimenti correlati
 
Approfondimenti correlati
 
 

DISCLOSURES

The statements above reflect the opinions and views of the Morgan Stanley Private Markets Solutions as of the date hereof and not as of any future date and will not be updated or supplemented. All forecasts are speculative, subject to change at any time and may not come to pass due to economic and market conditions.

Information regarding expected market returns and market outlooks is based on the research, analysis, and opinions of the investment team of the Private Markets Solutions Team. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific Morgan Stanley investment.

Certain information contained herein constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as "may," "will," "should," "expect," "anticipate," "project," "estimate," "intend," continue" or "believe" or the negatives thereof or other variations thereon or other comparable terminology. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. No representation or warranty is made as to future performance or such forward-looking statements.

Persons considering an alternative investment should refer to the specific investment’s offering documentation, which will fully describe the specific risks and considerations associated with such investment.

Alternative investments typically have higher fees and expenses than other investment vehicles, and such fees and expenses will lower returns achieved by investors. Alternative investment funds are often unregulated, are not subject to the same regulatory requirements as mutual funds, and are not required to provide periodic pricing or valuation information to investors. The investment strategies described in the preceding pages may not be suitable for the recipient’s specific circumstances; accordingly, you should consult your own tax, legal or other advisors, both at the outset of any transaction and on an ongoing basis, to determine such suitability.

This is prepared for sophisticated investors who are capable of understanding the risks associated with the investments described herein and may not be appropriate for the recipient. No investment should be made without proper consideration of the risks and advice from your tax, accounting, legal or other advisors as you deem appropriate.

Morgan Stanley does not render tax advice on tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used with any taxpayer, for the purpose of avoiding penalties which may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Clients should always consult with a legal or tax advisor for information concerning their individual situation.

This material is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM's affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.

This material has been issued by any one or more of the following entities:

EMEA: This material is for Professional Clients/Accredited Investors only.

In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited (“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson’s Quay, Dublin 2, D02 VC42, Ireland.

Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.

Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited ("EVMI") 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority.

Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain.

NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

Hong Kong: This material is disseminated by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to "professional investors" as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan Stanley Investment Management Company and should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore ("SFA"); (ii) to a "relevant person" (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore.

Australia: This material is disseminated in Australia by Morgan Stanley Investment Management (Australia) Pty Limited ACN: 122040037, AFSL No. 314182, which accept responsibility for its contents. This publication, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. Calvert Research and Management, ARBN 635 157 434 is regulated by the U.S. Securities and Exchange Commission under U.S. laws which differ from Australian laws. Calvert Research and Management is exempt from the requirement to hold an Australian financial services licence in accordance with class order 03/1100 in respect of the provision of financial services to wholesale clients in Australia

Japan: For professional investors, this document is circulated or distributed for informational purposes only. For those who are not professional investors, this document is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. ("MSIMJ")’s business with respect to discretionary investment management agreements ("IMA") and investment advisory agreements ("IAA This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.16% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above. Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This document is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.

 

La presente comunicazione ha carattere promozionale.

Prima di procedere è necessario leggere attentamente tutti i Termini e le Condizioni che illustrano i vincoli legali e normativi che regolano la divulgazione delle informazioni relative ai prodotti di investimento Morgan Stanley Investment Management.

È possibile che i servizi illustrati in questo sito Web non siano disponibili in tutte le giurisdizioni o a qualsiasi persona. Per ulteriori informazioni, si rimanda alle condizioni d'uso.


Privacy e cookie    •    Your Privacy Choices Your Privacy Choices Icon    •    Istruzioni per l'uso

©  Morgan Stanley. Diritti riservati.