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Finance

Private Equity's Mountain of Dry Powder Is a Danger Sign

Unspent capital is piling up in Asia as IPO flops and U.S.-China tensions block the exits for investors.

Corrected

Private Equity's Mountain of Dry Powder Is a Danger Sign

Unspent capital is piling up in Asia as IPO flops and U.S.-China tensions block the exits for investors.

Not a sign of success.

Not a sign of success.

Photographer: Getty Images

Not a sign of success.

Photographer: Getty Images

Investors keep flocking to private equity in Asia even though returns are declining. They should take heed: Payouts are likely to get worse from here, rather than better.

The hunt for yield in a low-interest world has spurred institutional investors from China Investment Corp. to Japan’s Government Pension Investment Fund to join the rush into the alternative asset class. Private equity firms founded by former veterans of Warburg Pincus and KKR & Co. are seeking to raise at least $4.5 billion for new funds investing in China, Cathy Chan of Bloomberg News reported Thursday, in the latest sign of the region’s burgeoning appetite for nonpublic investments.

New York-based KKR, meanwhile, is targeting more than $12.5 billion for its fourth Asian fund, which would surpass the record $10.6 billion raised by China’s Hillhouse Capital Group in 2018. 1  At the end of June, private equity firms in Asia were sitting on a record $361 billion of unspent capital, according to London-based market research firm Preqin.

Bigger and Bigger

Hillhouse has raised the largest private equity fund devoted to Asia to close so far

Source: Asia Private Equity Review

Note: Considers only funds that aren't owned by governments.

The returns haven’t lived up to the hype. Funds focused on Asia generated an internal rate of return of 12.8% last year, down from 15.5% in 2018, according to Preqin. That’s below what investors could have made outside the region: North American funds chalked up an IRR of 16.4% in 2019 while those centered on Europe returned 18%.

Even brand-name private equity shops have sputtered. Hillhouse’s $10.6 billion fund saw its IRR slip by 5.16 percentage points between September 2018 and the third quarter of 2019. Over the same period, the MSCI Asia Pacific Index dropped 3.3%, according to data compiled by Bloomberg. KKR’s two existing Asian mega-funds have had varying success.

Size Can Weigh You Down

Returns have been patchy for Asia's five largest private-equity funds

Source: Bloomberg/KKR

Note: Fund periods are Sept. 19, 2018 to Feb. 28, 2019 for Hillhouse; June 1, 2017 to Sept. 30, 2019 for KKR Asian Fund III; June 20, 2018 to June 30, 2019 for Carlyle; Dec. 18, 2012 to March 31, 2019 for KKR Asian Fund II; Jan. 3, 2018 to March 31, 2019 for Affinity.

It’s getting harder for private equity firms to realize returns by selling companies on stock markets as the world wakes up to the reality that not all hot technology startups will be IPO winners. That follows disappointing debuts for high-profile names such as Uber Technologies Inc. and Lyft Inc., along with the collapse of WeWork’s U.S. share offering last year.

Much of the private-equity action in Asia has focused on China, which has also had its share of setbacks. OneConnect Financial Technology Co., a unit of Ping An Insurance (Group) Co., cut the size of its U.S. IPO by almost half last month, while Oyo Hotels is firing thousands of staff in China and India. Like WeWork and Uber, both companies are backed by Japan’s SoftBank Group Corp.

The U.S.-China trade war has also had a damping effect, with some private equity-invested companies finding themselves embroiled in the tensions. Facial recognition startup Megvii Technology Ltd. delayed its IPO in Hong Kong after it was included in a U.S. blacklist cutting off its access to key American technology. Bytedance Inc., owner of the wildly popular video app TikTok, is now a subject of a U.S. national security review, and is weighing the sale of a majority stake in the unit.

All that considered, it isn’t surprising that the value of private-equity backed trade sales dropped 14% to $28.5 billion last year, according to data compiled by Bloomberg, while share sales by private equity owners slumped 27% to $6.4 billion, declining for a third year to the lowest since 2013.

Dry Powder

At the end of June 2019, private equity firms in the Asia Pacific region were sitting on $361 billion of unspent capital

Source: Preqin

Note: 2019 number is for the first six months of the year.

While the U.S.-China phase one trade deal signed last week offers some hope of an improvement in conditions, money is still likely to keep piling up in Asian private equity. For one thing, there aren’t many better alternatives. Institutional investors need to diversify: They can’t keep all their funds in U.S. equities, even if these have been going gangbusters for years.

But that doesn't mean individuals need to follow suit. Private equity investments are more risky because they are illiquid and take years to pay off. Smart investors should see the ever-growing piles of dry powder as a sign of danger rather than success.

--With assistance from Dani Yang and Irene Huang. 

 

(Corrects to remove non-annualized MSCI index comparisons in the second chart, deletes reference to KKR fund underperforming the market.)
  1. The Hillhouse fund is the largest devoted specificallly to Asian investing. Chinese state-backed, or policy, funds such as a $29 billion vehicle created in October to invest in the semiconductor industry are larger.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net