Late start may benefit Asian investors

The growing ranks of large Asian institutional investors making their first allocations to hedge funds and private markets now will provide a boost for global fund-of-funds firms.

Still, analysts expect asset owners in the region to move quickly to the direct investment end of the alternatives learning curve.

“Asia is playing catch-up,” but asset owners here should enjoy a “late-mover advantage,” compressing the time required to fully integrate alternatives into their portfolios, predicted Kevin Lu, Singapore-based chairman, Asia, for private markets manager Partners Group AG. Asia-Pacific clients accounted for roughly $6 billion, or 10%, of Partners Group's $57 billion in global AUM in direct private equity investments, infrastructure, private equity fund of funds and secondaries as of Dec. 31, up sharply from $2 billion, or 6%, of the firm's assets five years before.

Investors in the region have “the advantage of watching the world's mistakes and getting the opportunity not to repeat them,” agreed Paul Price, London-based head of global distribution with Morgan Stanley Investment Management.

A case in point: Investors in Asia are at the forefront of a “revolution on the alternatives side” focused on “the development of bespoke solutions,” in lieu of the off-the-shelf, commingled strategies an earlier generation of U.S. asset owners turned to, said Mr. Price.

“We're in the engineering business of creating customized strategies” for clients with unique target mixes for risk, return, volatility and liquidity, among other criteria, said J. Tomilson Hill III, New York-based president and CEO of Blackstone Alternative Asset Management, which invests more than $73 billion of client money globally in hedge funds and provides advisory services for another $30 billion.

In a January 2011 interview with Pensions & Investments, Mr. Hill said Asia-Pacific clients accounted for roughly 10% of the firm's AUM. A Blackstone spokeswoman declined to provide an update.

Industry analysts say the proportion has likely grown to around 15%.

Growing demand in Asia for customized hedge and private equity “funds of one” strategies should boost business for legacy fund-of-funds firms that have struggled following the global financial crisis, noted Mr. Price.

MSIM's combined AUM in customized strategies and hedge funds of funds stood at $22.4 billion at the end of 2015, according to Willis Towers Watson PLC's Global Alternatives Survey 2016.

As Asian asset owners go up the alternatives learning curve, analysts predict they'll follow the same path as their U.S. counterparts before them — shifting allocations from funds of funds to direct investments with underlying managers, as well as co-investments and direct investments in unlisted companies, real estate or infrastructure.

The region already boasts big institutional investors at every point along that path.

A handful — including Singapore sovereign wealth fund GIC Pte Ltd., with estimated assets of more than $300 billion, the $810 billion China Investment Corp. and Australia's A$129.6 billion ($97 billion) Future Fund — already play in the same league as the big Canadian pension funds, making direct investments in private companies, infrastructure and real estate.

Others are well on their way.

In an email, Mohamad Nasir Ab Latif, deputy CEO (investment) of Malaysia's 731 billion ringgit ($168.3 billion) Employees Provident Fund, said the EPF largely has shifted from its initial allocations to private equity funds of funds, begun just over a decade ago, to “individual top-quartile managers.”

“We are also cautiously venturing into co-investments” with those managers, networking with other limited partners and global pension funds to explore suitable opportunities, he said.

At the close of 2016, the EPF reported a 4% allocation to real estate and infrastructure. Mr. Mohamad Nasir declined to confirm estimates by industry players that the EPF's allocation to private equity stands around 2%.

The latest crop of institutional investors in Asia expanding their alternative investments or making their first forays in hedge funds or private markets includes the big public or quasi-public funds in North Asia, which invested the bulk of their money in government bonds until rock-bottom yields in recent years forced them to consider other options.

Among them, South Korea's 565 trillion won ($496 billion) National Pension Service, a private equity veteran, added its first allocations to hedge funds of funds last year. Meanwhile three Tokyo-based investors coming to the alternatives table now — ¥207.8 trillion ($1.86 trillion) Japan Post Bank Co. Ltd., ¥144.8 trillion Government Pension Investment Fund and ¥80.3 trillion Japan Post Insurance Co. Ltd. — are focusing on funds of funds as a first stop but signalling near-term moves to invest directly.

Some market veterans predict an expedited move up the learning curve for those investors.

“The period of time required for investors in Asia to move through that lifecycle is likely to be shorter than what we've seen in the U.S. and Europe, primarily because of a strong desire to move toward co-investments and direct deals over a short time frame,” said Alvin Tay, Singapore-based managing director and head of Asia for investment consultant Cambridge Associates LLC.

Katsunori Sago, director of Japan Post Bank's investment program, said in a March interview that over the previous 18 months his firm started investments in hedge funds, private equity and real estate.

Japan Post Bank has a 3% target ceiling for alternative allocations — just more than $57 billion at current exchange rates. Roughly two-thirds of the bank's initial $2 billion in allocations last year have gone to customized hedge fund-of-funds strategies.

Mr. Sago said Singapore's GIC Pte Ltd., one of the world's most active investors in unlisted companies, real estate and infrastructure, is one model Japan Post Bank could follow.

He said within a year or so, by the third year of his tenure, he will have assembled a team fully capable of forging partnerships with top-tier private markets managers.

Takayuki Haruna, managing director and head of credit and alternative investments with Japan Post Insurance, said in a separate interview in March that his team hoped to begin making allocations starting April 1. Market veterans say those first allocations are likely to go to fund-of-funds strategies.

On April 11, meanwhile, GPIF — with $64 billion slated for alternatives allocations — issued its first alternatives RFP for managers of customized private equity, real estate and infrastructure funds of funds. The RFP said those funds would be the first pillar of an alternatives strategy that eventually will include co-investments with other institutional investors and direct investments in underlying funds.

A GPIF spokesman said in an email that Japan's Ministry of Health, Labor and Welfare recently decided to allow GPIF to make limited partner investments in private equity, real estate and infrastructure funds, and only awaits a cabinet order to go into effect. Further information could not be learned.

Executives with firms that came to prominence on the strength of their hedge fund-of-funds strategies say allocations by those heavyweight Japanese asset owners, South Korean funds, led by NPS, and other pools of capital in the region should leave clients in Asia accounting for a growing chunk of their global businesses.

Sufian Omar, Singapore-based managing director, international sales, with EnTrustPermal, the $25.2 billion hedge funds-of-funds and customized accounts manager formed last year by the merger of Legg Mason's Permal Group and EnTrust Capital, said Asian clients accounted for 15.6% of the firm's AUM by the end of 2016. Five years before, just as EnTrust was launching its efforts to build an Asia-Pacific business, clients in the region accounted for 11.3% of Permal's business.

Asia has “definitely been a driver of flows,” with business from the region picking up noticeably over the past year or two, said an executive with a big hedge fund-of-funds firm, who declined to be named.

Anticipated alternative allocations over the coming five to 10 years of more than $100 billion by those Japanese whales — perhaps 70% or more for real estate — would be significant in themselves, but smaller, still significant pools of institutional capital should follow in their wake, industry veterans say.

In a market where GPIF's decisions provide an effective seal of approval for allocations to new asset classes, other pension funds are likely to follow suit “a couple of cycles down the track,” said Richard Tan, Hong Kong-based senior investment consultant and head of private markets, Asia, with Willis Towers Watson.

That could ensure that the pickup in business opportunities for private equity or real estate funds of funds isn't short-lived, predicted Scott Collison, who joined Sydney-based real estate credit asset manager Banner Asset Management at the start of 2017 as head of institutional business, after serving as Franklin Templeton's Investors' Singapore-based head of alternative sales in the region.

Even if a client's interest in funds of funds is primarily as a tool to gain familiarity with an asset class, it could take three or four years to come up to speed, for example, on core real estate and then a similar time span to do the same with opportunistic real estate, Mr. Collison noted.

Increasingly, however, with the shift to custom strategies — and a strategic partnership foundation — executives with legacy fund-of-funds firms say those old rules may no longer apply.

For starters, industry veterans contend “fund of funds,” with its connotation of a commingled product, is out of date in describing their business focus.

“Professional hedge fund investor” is a better label, said EnTrustPermal's Mr. Sufian.

Meanwhile, the idea that clients are looking to chew up and spit out providers as quickly as possible is likewise off the mark in today's markets, said John McCormick, a New York-based senior managing director and head of global business strategy for Blackstone Alternative Asset Management.

For large institutional investors looking to put billions of dollars to work, “having a strong partner is a permanent part of your plan,” he said.

The biggest asset owners need to take advantage of every avenue for getting exposure to private markets, said Partners Group's Mr. Lu.

MSIM's Mr. Price struck a similar note, contending his firm's range of capabilities in crafting custom funds of one in private equity, hedge funds or secondaries is helping MSIM pursue more opportunities in Asia. Prospective clients in Asia now account for roughly four of the firm's 10 active discussions globally now on customized solutions, up from one five years ago, he said.

Meanwhile, when investment portfolios reach a certain scale, an asset owner can turn to providers of fund-of-funds or fund-of-one strategies to invest in smaller, niche opportunities that it wouldn't make sense for the asset owner to do internally, market veterans say.