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Private equity giants home in on Asia Pacific

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When Doug McTaggart, the CEO of Queensland Investment Corp- oration (QIC) addressed
a recent conference in Melbourne, he announced a big push into private equity and other alternatives. “As an asset class, I think it’s great,” McTaggart told the audience, though he admitted the market could be getting a bit “toppy”.

The Brisbane-based investment manager is one of the biggest institutional investors in Australia, with A$50bn (€30.1bn) under management. It plans to boost its allocation to real estate, private equity and infrastructure investments to 20% of the portfolio.

Though the fund currently has around 10% of its money in real estate, it only invests 1% to 2% in private equity, and a similar amount in infrastructure investments.

The change of strategy being made at QIC is still the exception but it is becoming more common
for institutions around the Asia Pacific region. The Japanese and Australians are the biggest institutional users of alternative investments in the region. QIC’s decision could be a sign of things to come. It has been targeted as a possible model for the Australian government’s Future Fund to follow.

The Future Fund is being designed to meet the Australian government’s superannuation liabilities for all government employees, which it estimates will hit A$140bn by 2020.

The Future Fund’s new general manager, Paul Costello, has already indicated that the fund may invest in private equity and other alternatives, though he didn’t indicate any kind of target allocation range. Costello’s former employer, the New Zealand Superannuation Fund, has already gone down that path. It made its first allocation to private equity in 2005, investing NZ$24m ($17m) in the AMP Pencarrow Private Equity Fund, a local start-up.

Asia Pacific hedge fund and private equity managers say local institutions still tend to favour managers based in Europe and the US rather than in the region.

Perversely, Asian alternative managers tend to get most of their investment from funds of funds and institutions in Europe and the US, which are keen to diversify into Asia.

Japanese institutional investors have undoubtedly been the most active institutions around the world when it comes to allocations to alternative investments. Japanese banks have also led the charge into private equity.

A 2007 report compiled by Kyoto University and the Swiss private equity fund of funds manager Adveq shows that 25% of Japanese institutions are already investing in private equity. The allocations only amount to a fraction of their assets under management but the research predicts a trebling of allocations over the next five years.

Japanese institutions have tended to make their private equity allocations at home - 67% of commitments were directed towards the Japanese domestic market. Kyoto University and Adveq found the main reason for Japanese institutions to buy into private equity is to generate better returns.

They seek an average absolute return of 13.3%. Industry associations were the heaviest users of private equity, with 37.8% using the asset class. That drops to 18.5% of corporate pension funds, 9.9% of insurance companies, 8.6% of banks and 25.2% other institutions.

Allocations from the banks are dropping though. They have redeemed trillions of Yen in alternative investment allocations as they prepare to deal with new banking laws developed to comply with the Basel II framework. Industry sources suggest banks in Japan may have recently redeemed between $4bn and $5bn, some 7% of the $69bn placed in hedge funds by investors from Japan.

In theory, the Basel II framework requires banks to know exactly what they are investing in. If a bank cannot break down the underlying assets of a fund, it could face capital charges.

The fund would have to generate consistent returns of more than 50% to justify holding it over a corporate bond yielding just 5%. The bank would have to set aside more capital to maintain its investment in the fund, possibly equal to as much as 100% of its original investment.

That is a problem for Japanese banks, especially less sophisticated regional ones, that invest in funds of funds. Some observers have suggested the Japanese banks may be using the Basel II changes as a smokescreen to unload poorly performing funds.

In Hong Kong, only a couple of institutional investors have reported alternative allocations.The Hospital Authority Provident Fund Scheme first placed $120m with two funds of funds managers in October 2004.

It declined to name the funds but they are thought to be Seattle- based Quellos Group and London-based Financial Risk Management. The management board originally intended to place 5% of the assets in alternatives.

To maintain that proportion, Yvonne Chan, the scheme’s assistant director of investments, said the fund would start looking for a third fund of funds manager because its original allocation had shrunk to only around 3.2% of its roughly $3.7bn in assets under management.

The scheme would need to place roughly $65m into hedge funds to bring its allocation up to its initial level. The Hospital Authority has used Towers Perrin as a fund consultant in the past. But there has been no word on a new allocation. The Hong Kong Jockey Club made Hong Kong’s first institutional allocation to alternatives when it awarded its first mandates to hedge funds in 2002.

The Jockey Club has some $164m in hedge funds out of a total $4.7bn under management, around 3.5% of assets.

The treasurer of the Jockey Club, Jacob Tsang, is encouraging the board to consider increasing the allocation and diversifying further its $2bn charity fund. It originally invested via its general fund.

The private equity action is particularly shifting into China. Oaktree Capital Management has already built up a team of 35 people in Asia, opening offices in Hong Kong in 2005 and Beijing in January 2007.

Most recently, it announced it had hired Ralph Parks as the chairman of Oaktree Capital Management (Hong Kong) Ltd, giving him oversight of Oaktree’s operations in the Asia Pacific region. Parks was previously chairman and CEO of Asia Pacific for JP Morgan.

Darby Overseas Investments, the private equity arm of Franklin Templeton, has snapped up Sean Wallace, the former head of capital markets in the Asia Pacific region for JP Morgan.

The company recently closed a $610m Korea Emerging Infrastructure Fund, a joint venture with Korea’s Hana Bank.

New York-based hedge fund DE Shaw announced in late February that it has hired Liang Meng as the first CEO of DE Shaw’s new Greater China private equity unit. Meng, who was co-head of China investment banking at JP Morgan Securities, will be based in Hong Kong.

Bain Capital and Kohlberg Kravis Roberts have also been making eyes at China. And the Blackstone Group in January announced it had hired a big hitter, Hong Kong’s former financial secretary, Antony Leung, to head a new private equity operation in Hong Kong.

Leung will co-head an expanded Hong Kong office together with Ben Jenkins, already a senior managing director with Blackstone, who is moving with a team of people to Hong Kong from New York.

It is the second private equity office for Blackstone, which opened in Mumbai in 1995.

Its presence may not only track down deals in the region but also attract new institutional investors from Asia.

Hedge fund/private equity hybrid Cerberus Capital Management, already active in Japan, is eyeing China.

It has brought former US Treasury Secretary John Snow on board, and China will be one of his targets. Snow said he would be using his high profile to open doors in China and India after joining Cerberus last October. “I think they expect me to be in places like China and India, where government approvals are required,” he said.

Alex Frew McMillan is a freelance writer based in Hong Kong

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