Heightened risk aversion and a commensurate lull in transactional activity hit Asia’s private banks hard. The lone star performer, this year, has been private equity and there is little evidence to suggest that the asset class will slow down any time soon.
Transactional income vaporising
2016 has been a chilly year for those private banks without an alternatives shelf. Especially so, when considering the washout of 2015, when equity day traders were sidelined having earlier enjoyed a surge in the Shanghai Composite beginning in late 2014.
Global transaction-based income, which includes equity and fixed income cash products, investment funds and structured products, fell 24% year-on-year in the second quarter alone, with Asia taking a heftier hit, according to a recent UBS financial report. APB Mandate’s own data shows that equity structured product volumes for wealth managers have plummeted by up to 30% over the past year – a decline felt especially by houses that do little in the way of non-flow trades.
Those private banks that have not already delegated fixed income management are being forced to navigate unchartered territories as central banks persist with fiscal stimulus programmes and ultra-low rates. Sources indicate that some private banks have burnt their fingers betting on policy direction via constant maturity swap notes, with monetary bigwigs acting unpredictably.
Although hedge funds are an intuitive solution for generating returns irrespective of market direction and volatility, sniffing out performers is no easy feat.
Year-to-date, global investors have pulled out US$55.9 billion from hedge funds, including a US$25.2 billion outflow in July – the largest monthly redemption since February 2009. According to Bloomberg, hedge funds delivered 1.2% industry-wide in 2016, compared to the S&P 500’s 7.6%.
Slim pickings in traditional asset classes and hedge funds have paved the way for one star performer: private market investments.
“Lower yields and returns across asset classes are a key driver of investor interest in private markets,” says Andrew Lee, deputy global head of UHNW & alternatives at UBS Wealth Management, adding that greater downward pressure on global yields emerged after the Bank of England (BoE) responded to this year’s Brexit vote outcome.
“Bonds are unlikely to be able to serve as portfolio diversifiers to the same degree that they have historically… and investors who have limited near-term need for liquidity are increasingly evaluating private markets as a way to enhance expected portfolio returns with similar volatility risk, further diversifying return drivers and increasing potential to access manager alpha.”
Chinese HNWIs continue to board the train to go global
Unsurprisingly, Chinese HNWIs lead the pack in terms of outbound private buying, coinciding with an aggressive corporate buying spree that has involved high-profile global brands such as Volvo, Football Club Internazionale Milano and the landmark Waldorf Astoria, and a number of push factors, most notably a weakening yuan and domestic slowdown. A recent AVCJ report shows that cross-border private equity reached US$16.4 billion by mid-2016, breaking 2012’s record.
In broad terms, the increase in appetite for private market deals is driven by a structural transformation in China’s economy, from export-led manufacturing to technology, industrial know-how and consumption. Corporate buyers have adjusted their priorities, accordingly, with private clients following suit.
“Chinese companies are acquiring North American and European companies to enhance technological capabilities and move the nation’s industrial sector upstream, to obtain high-value brands that can be offered to the maturing consumer in China, and to build scale and distribution in strategically important markets and geographies,” says a J.P. Morgan report.
“Chinese companies are looking beyond market share in China to global markets, with their sights set on becoming market leaders globally.”
For example, Beijing-based wealth manager, CreditEase (US$6 billion AUM as of 2015-end) is reportedly aiming to raise US$200 million for a global private equity fund focusing on businesses in consumer, telecom, healthcare and industrial sectors, with a minimum entry level of US$150,000. The firm is already managing a US$30 million Israeli Innovation Fund that primarily focuses on Israeli and American private technology firms operating in the tech, media, telecommunications, healthcare and smart materials spaces.
At Noah Private Wealth Management, clients have bought more than US$2 billion of private equity products in the first half the year, accounting for 26% of all investment product flows. Its group president, Kenny Lam, says that private equity accounts for approximately 15-20% of its clients’ portfolio allocations. He adds that the demand also encompasses domestic opportunities in China covering a broad range of industries such as education, technology, media and telecommunications.
“The phenomenon of Chinese going global alongside drivers like renminbi depreciation and demand for diversification is not a new topic; and what you are seeing is domestic players, like Noah, capturing a part of that flow,” Lam tells Asian Private Banker, adding that the breadth and exclusivity of deals on its offshore platform are a source of competitive advantage over global private banks.
“Within [clients’ PE allocation], half has been allocated to domestic private equity – this is a space where we still see has a lot of room to grow.”
And the pace of Chinese outbound investments is only accelerating.
According to a recent Dealogic report, Chinese outbound M&A for the first four months of 2016 reached US$96 billion (it climbed an extra US$14.8 billion one month later), four times more than for the same period last year. This total also represents 9.7% of the global sum compared 1.2% in 2015.
Still, no walk in the park
With valuations frothy, the global recovery still playing out and numerous uncertainties looming, private assets are a ‘natural’ instrument to help insulate clients from daily volatility or risky short-term plays that depend on unpredictable central bank policies and political referendums.
Even so, private asset sales to Asian HNWIs are not necessarily plain sailing, despite the steady uptick in demand.
Top players in Asia with a sizeable UHNWI base will typically garner between US$50-150 million when fundraising, but the number of deals per year can vary substantially, according to industry estimates.
Sources share that several top five private banks in the region will successfully execute three or fewer deals per year, while other smaller players can execute as many as ten, depending on client needs and preferences.
Liquidity, transparency and, of course, income are among the major hurdles private banks need to overcome to win business.
Though the ability to find underliers that resonate with clients – particularly with regards to their core business – is what can make or break a deal, private banks’ ability to structurally tweak solutions to address other inhibitors can also increase the attractiveness of private asset opportunities.
“[On] the issue of liquidity, we, alongside others, have cracked this nut with a monthly redemption feature for selling positions,” says Donald Rice, APAC head of alternatives at Credit Suisse’s private banking arm, who points out that current alternatives allocations from regional client portfolios reach as high as 40-50%.
Rice explains how Credit Suisse has been able to resolve this issue by constructing portfolios with exchange-listed programmes alongside advanced secondary positions that blend with private debt positions. This enables a gating provision that can mitigate liquidity concerns, especially for investors who had poor lock-up experiences in 2008.
“Secondly, is the demand for distributions early on, rather than wait the full seven-to-ten year lock-up period,” Rice continues.
“We’ve managed to tackle this issue by offering a coupon in our debt solutions as well as shorter duration products. Finally, is the issue of transparency. For clients that want visibility, we have been showing secondaries rather than blind pools.”
Plenty of fuel left
Yet, despite varying degrees of success in Asia, optimism amongst wealth managers remains high; and the trend of private asset investing is expected to sustain for years to come.
“Whilst some private banking clients in Asia have been investing in private markets for many years, on average, the overall penetration level in the majority of client portfolios remains relatively low,” notes Leighton Mattheson, head of private markets, APAC, investment products and services at UBS Wealth Management, underlining the slow pickup of new investors in the region.
“However, over recent periods, we have witnessed a significant increase in both client interest and investment activity. We believe this shift in behaviour is being driven primarily by clients seeking diversified sources of alpha, coupled with an enhanced degree of asset class familiarity and product access. Given the low yield investment environment, we expect this trend to continue.”
The bank expects this trend sustain across generations, and has recently launched a Swensen-inspired ‘Endowment Style’ discretionary portfolio management (DPM) solution, as part of a larger DPM innovation roll-out.
UBS WM’s ‘Endowment Style’ portfolio currently allocates 22-40% to private markets with a weighting of up to 32% in private equity, depending on risk profiles.
And despite the relative nascency of private asset investing amongst HNWIs in the region, UBS’ Andrew Lee sees signs of maturation as evidenced by a growing demand for deeper parts of the market.
“Historically, the majority of private market investments by HNWIs in Asia have been in the form of large-cap, brand name private equity funds,” Lee says.
“Whilst we expect this to continue, we have observed a notable increase in clients seeking enhanced diversification, including access to the mid-market and more specialist investment strategies, [including private credit, real estate and thematic investing]”.
Efforts to either introduce or bolster private equity offerings are not slowing down as private banks in the region work to secure true long-term recurring income against a backdrop of difficult markets and mounting expenses – the Monetary Authority of Singapore recently announced that accredited investors would be offered retail-level protections in a move that is expected to further increase compliance costs.
In December 2015, DBS Private Bank launched a new offering targeting UHNWIs dubbed ‘PE Access’ – an “introducer model” that informs clients of new deals who must then perform their own due diligence before investing. It targets clients with a minimum net worth of S$50 million (US$36.7 million) and the minimum ticket size is S$5 million (US$3.7 million).
In March this year, Standard Chartered Private Bank introduced its new private equity offering, Pegasus Series, which aims to provide less accessible funds at a “substantially lower investment point”.
And in May, Bank of Singapore announced that former CIO Hou Wey Fook’s role had changed to solely focus on managed investments, while also highlighting a 2015 fundraising with Blackstone that topped US$170 million.
Even those private banks in the region that neither have the access nor scale to launch alternative offerings that outshine larger competitors are pursuing innovative solutions to capture private asset flows from Asia.
“Although we are small in Asia, we, like many other Swiss boutiques, have a very strong European network,” says one Singapore-based head of a pure play.
“Large deals may go through the usual institutional channels but we also bank many, many SME owners who are seeking new sources of funding through equity or debt. We can connect them to Asia and vice-versa.”