Chris Healy, CAIA
March 6, 2022
Anyone who has spent a significant amount of time with a broad range of institutional investors will tell you that while there are slight degrees of commonality, each individual organization is especially unique and nuanced. Investors are easily defined by type and to a lesser extent investment style, but that’s about it. It’s impossible to make blanket characterizations about investors’ specific interests, preferences, constraints, and processes.
There are, however, behavioral tendencies that permeate large swaths of the investor community. The endowment model, for example, was initially conceived by innovators, gradually accepted by progressives, and then widely implemented. Behavioral changes that are widely embraced at scale are typically in response to innovation or events of significance. Some are lasting while others are temporary.
I’ll refrain from reciting the specifics as to how Covid has reshaped the methods and ways in which business is conducted, let alone our daily lives. However, it’s worth exploring prevailing behavioral changes and newfound tendencies on the part of investors along with the resulting opportunity. The purpose of this exercise is entirely without malice. It’s undeniably understandable that the constraints of today require adaptation.
A behavioral trend that has appeared with high frequency post covid is that investors are doing more with less. More investment with fewer manager relationships. Managers with diverse and expansive existing LP bases have been massive beneficiaries of this phenomenon. As investors look increasingly "inward” the incumbent GP has had the major advantage.
Within private markets, fund re-up’s have been front and center. This makes a lot of sense. Why not go with who you already know and presumably like? It’s also the path of least resistance and takes less work. It would be interesting to see how much time is spent jockeying for allocation vs. investment underwriting. With re-ups consuming resources and attention, investors are concurrently missing out on other great opportunities.
At BridgeWood, we spend a lot of our time focused on Asia. Surprisingly, in today's environment, even preeminent Asia based managers with strong track records of success face challenges winning new LP capital.
For U.S. investors, Asia inherently comes with greater friction than close to home alternatives. Asia has always been a harder sell and perennially fraught with reasons for caution. The last few years are no exception as evidenced by the trade war and today’s evolving China government policy. Tomorrow, we’ll have something new to worry about.
At the same time, progressive investors that have looked through prevailing noise and had access to the region’s best managers have done very well. That will likely continue. It’s also true that the best managers are often scarce.
This brings us to the current opportunity –The challenges and constraints of today create opportunities for the less constrained investor. What exactly does that mean?
Managers that have historically been mostly inaccessible have capacity. Today, allocations to the Asia region are primarily being accomplished through re-ups. This has diverted attention away from what would ordinarily be the ongoing scouting and sourcing of top talent.
The result is that the many of the natural buyers for Asia/China VC and growth equity funds have moved to the sidelines. How do we know this? We speak with them every day. If unencumbered, many investors have indicated that the opportunities available today would be highly actionable. Like financial markets, huge shifts in the buyer base of an asset typically result in some corresponding dislocation. The dislocation here is not a function of price, but of access and capacity. Under normal conditions this access, and excess capacity would likely be non-existent.
Exceptional multi-billion AUM Asia based managers are in market with Fund II and beyond that have limited excess capacity. These are large established institutional firms with blue-chip investor bases comprised of sovereign wealth funds, pensions, E&F, family offices, along with the sponsorship of several major consultants. They have strong alignment of interest with LPs and are amongst the largest investors in their own funds. The principals of these organizations are visible, known, highly pedigreed, and have extraordinarily deep reservoirs of LP and industry references. Unlike more obscure and less widely known managers, these groups should be relatively easy to diligence, even now from the confines of one's desk afar.
On the early-stage China VC front, we’re seeing strong performers that have been at the forefront of China innovation in areas like consumer, enterprise SaaS, deep tech, web 3.0, and the digital asset ecosystem. These are deeply entrenched VCs, with extensive moated networks of repeat entrepreneurs, and an impressive history investing at seed and series A stages. Given the long-term duration of venture capital, the China policy concerns of today may be very old news towards the latter years of the fund's lifecycle. Investors might consider asking, will the China of 2025 and beyond be in a better position that the China of 2022? It’s also worth noting an emerging trend, Chinese entrepreneurs and China VC backed companies are not monolithically targeting the domestic Chinese end- market but are looking outward at large addressable international markets.
On the late-stage growth/Pre-IPO side, we have a group that specializes in several areas of sector domain expertise: healthcare/biotech, SaaS enterprise, fintech, and consumer. They target investments across developed and emerging Asia, along with U.S./global companies, where an economic or thematic nexus to Asia exists. While China is a component, the strategy is geographically diversified with current investments in Japan, South Korea, Indonesia, and Asia themed companies located in U.S./global jurisdictions. This makes the fund less sensitive to evolving China policy changes. This group focuses on de-risked growth opportunities at series C and beyond in companies that are valued at less than $1 billion at the time of investment.
The managers in our purview have 100% re-ups from existing investors. Unlike mega firms and some peers, these groups are targeting relatively small-to-mid-sized funds despite their depth and breadth. By design, this allows them the ability to stay nimble and hyper focused on performance. Subsequent funds will be of similar size ($400-$500 million), and much like today, are expected to be largely consumed by existing investor re-ups. At present, these funds are successfully nearing target capacity and approaching final closing timelines. With that said, they’re interested in a select number of new relationships with high quality like-minded investors that value long term partnerships.
In some cases, these funds are no longer blind pools. Numerous investments have taken place and investors can get a free look at the current portfolio. This also provides more “meat” for investors to digest and underwrite along with prior fund investments.
The investment of today becomes the re-up of tomorrow – future capacity constraints will result in follow on funds mostly consumed by existing investors. With the natural buyer base on hold, investors that can act today will be the enviable position of having established a long-term partnership with what we consider to be preeminent Asia GPs. At a minimum, investors that are less constrained might consider establishing toe-hold positions (amounts below their typical investment size).
This opportunity, much like other effects of the pandemic will pass. The pre-covid regime where old and new GPs compete on a mostly level playing field will resume. The onerous restrictions curtailing travel to and from many parts of Asia will end. At that point, these capacity and access opportunities will be largely gone.
About: BridgeWood is a boutique alternative investment placement firm with a presence in Hong Kong and New York. The firms seeks to connect progressive investors with unique and differentiated sources across the globe.
For additional information on BridgeWood, please visit www.bridgewoodalts.com and feel free to reach out to us directly.
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