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25 May 2021
CaelusWatch: What’s going on in the global private equities space? (I)
by Candice Wan, Analyst, Caelus Hong Kong Office

The private equities (PE) industry appears to be mysterious to many, but as the industry continues to innovate and develop, investors are getting more familiar with this alternative investment.

The industry is typically composed of PE funds that act as investment vehicles, investors that invest in these funds, and PE or asset management firms that manage these pools of funds. Most PE funds hold a long-term portfolio that invests in companies with high return prospects, often aiming at achieving high-single to double-digit returns, balancing the return expectations with the risks involved over the longer term.

The majority of PE firms in Hong Kong have chosen to locate their funds offshore such as the Cayman Islands, as investors are more familiar with these jurisdictions. However, the increasing cost of maintenance, the OECD’s implementation of the base erosion and profit shifting (BEPS) framework, the Cayman Islands’ enactment of the Private Funds Law, Hong Kong’s new limited partnership fund regime, etc. prompted more Hong Kong asset managers to consider establishing onshore private funds in Hong Kong.

The Global Private Equity Landscape
Over the last decade, private equity has grown almost tenfold in net asset value, outpacing public equity market growth by nearly three times. These growth rates slowly diverged during the Global Financial Crisis in 2008, and this divergence has continued over the last decade, as shown in the graph above. This implies that despite public equity’s liquidity, private equity offers much higher investment upside.
According to “McKinsey Global Private Markets Review 2021”, private markets fundraising was down across most asset classes and regions in 2020 after a record year in 2019. While fundraising volatility coincided with COVID-19 in the first half of 2020, total AUM across private markets (including private equity, real estate/private debt/natural resources/infrastructure closed-end funds) continued to rise to an all-time high, reaching US$7.4 trillion. Private equity accounted for the largest percentage of the growth. Global private equity assets under management reached $4.5 trillion, up 6% from 2019, or 16.2% annually since 2015, showing a persistent increase in asset allocation to PE.
When the pandemic hit its peak in the second quarter, PE activities including investments, exits and fundraising dropped sharply before recovering in the fourth quarter as confidence returned when LPs and GPs have adapted to the remote environment. The impressive rebound was due to dry powder piling up since the beginning of the coronavirus outbreak, the pressure of GPs having to move the needle for LPs, and pent-up demand for alternative investments.

In Asia Pacific, dry powder is growing at 22% over 2019-2020, as stated by Preqin. Travel bans restrict physical meetings between management teams and PE firms and conducting due diligence in person. This has resulted in extended acquisition timelines and delays in closing deals. However, valuations have remained steady which provides support to the seller’s market. Thanks to virtual meetings and vaccine distribution throughout the year, we expect capital raising and the exit market including both IPOs and trade sales will stay healthy.

Challenges Ahead
Financial market volatility, exacerbated further by COVID-19, trade frictions, and macroeconomic risks are going to pose challenges to GPs in the coming decade that will drastically change the investment outlook for countries, regions, and investors. These risks are causing many investors to be on the fence and become more hesitant.

With uncertainties and volatility going on in financial markets, PE funds are increasingly looking for new avenues of growth, and the technology sector is one of the main sectors that Caelus is keeping an eye on. In spite of the recent tech stocks slump, the sector offers faster-than-average growth and was widely recession-resistant during the last global financial crisis.
Chance favors the prepared mind. PE firms that can ride through the storm and perform well during challenging times are usually those that can anticipate disruption, keep abreast of market trends and have extensive sector expertise. GPs who are able to outperform in an unpredictable market adjust strategies before the market shifts, take more control of deals and manage their portfolios more actively.

Truer now than ever, PE firms are less susceptible to market correction as they are investing in private companies and their talent, emphasizing deal assessment, ensuring long-term profitability, and supporting the commercialization of their portfolio companies’ innovations.

Coming up next, we’ll look at what is going on in the PE space in Hong Kong.

The author is a Securities and Futures Commission licensee, and no part of the author’s compensation was, is, or will be, directly or indirectly, related to the specific material contained herein. The author does not personally hold the mentioned relevant shares.

The commentary, news, research, analysis, prices and other information published in this column can only be viewed as general market information, which is for reference only and does not constitute investment advice. Caelus Asset Management Limited is not responsible for errors, inaccuracies or omissions in the information, and does not guarantee the accuracy or completeness of the information, text, diagrams, connections or other items contained therein. The company shall not be liable for any special, indirect, joint or consequential damages caused by the materials, including but not limited to loss, loss of income or loss of profit.