Shadow capital stabilised South-east Asia private equity in 2020: report

SOUTH-EAST Asian private equity (PE) deal value fell by over 50 per cent year on year in the first three quarters of 2020 and the brakes were slammed on exits, amid Covid-19 uncertainty. This comes on the back of a thriving 2019 for the region's PE and venture capital (VC) scene, which clocked US$12 billion in deal value.

Shadow capital investors were undaunted, however, deploying direct capital throughout the cycle. This is according to Bain & Company's report, "Shedding light on shadow capital in Southeast Asia", released on Thursday.

Prior to Covid-19, the PE/VC scene was holding up well. 2019 was the third year in a row for South-east Asia in which deal value held above the US$10 billion mark, noted the report. In the seven years prior (barring US$10 billion in 2014), deal value had ranged from US$6 billion to US$8 billion annually.

A new record of nearly 400 startups also received their first round of funding in 2019, with about 100 receiving a second round. Meanwhile, four new and nearly-unicorns joined the ranks: OVO, valued at about US$2.9 billion, as well as PropertyGuru, VNPay and Zilingo, valued at about US$1 billion each.

With the onset of Covid-19, however, PE deal value plummeted in 2020. Average deal size in South-east Asia was 40 per cent smaller year on year, driven by an absence of mega deals in excess of US$1 billion. Exit activity was also muted, with no recorded exits in the first half of the year.

Fund managers are now facing expanding and ageing portfolios, with steady investment but fewer recorded exits. Several PE funds in the region now find themselves unable to raise additional capital without demonstrating strong realised returns in the existing fund, said the report.

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But throughout 2020's market turmoil, shadow capital investors seemed unfazed. The report showed that a string of such investors - like Singapore's GIC and Temasek, Abu Dhabi's ADIA, family-owned Verlinvest and corporates like Tencent, to name a few - participated in South-east Asian and Asia-Pacific PE deals throughout 2020, helping to stabilise the scene.

Shadow capital allows institutional investors to access PE assets without having to depend on general partners (GPs), giving them lower costs and increased control over their investments. They are increasingly making their mark in the region.

According to the report, over 75 per cent of the 30 highest-funded South-east Asian startups (by published capital raised) have received shadow capital investments. In 2019, shadow capital investors amplified deal activity by participating in 60 per cent of all South-east Asia deals.

Shadow capital brings tremendous value to the region's startups and private companies, said the report. It is perceived as "patient capital", for its longer time horizon compared to fixed-life funds. This offers benefits like steady allocation to GPs throughout cycles; anchor investments and fundraising for promising startups, with a long-term vision; and stepping up with portfolio teams to drive value creation and sustainability.

But the report also flagged that the heat has been turned up for GPs, who increasingly find themselves bidding against shadow capital investors for deals, and competing with them for talent. Sovereign and government linked funds were singled out for adding to the pressure, with "huge Singapore and Malaysia-based teams drawing in top talent", the report said.

The hotter competition is driving a race among investors to diversify and expand their capabilities. One unnamed "South-east Asian sovereign wealth fund" is said in the report to have more than quadrupled its headcount ratio of data analytics, software engineering and cybersecurity employees between 2015 and 2020, relative to its amount of assets under management.

"The role of shadow capital has become increasingly prominent in recent years, bringing tremendous value to South-east Asia's startups and private companies, with stable, patient capital that can invest through cycles," said Alex Boulton, Bain partner in South-east Asia and co-author of the report. "Shadow capital investment has helped maintain the strength of the South-east Asia market throughout the Covid-19 crisis and has raised the bar for investor talent models - now top of mind for investors," he added.

Fund managers will need to be agile and adjust to new paradigms, including to rethink their operating and talent models to keep pace with shadow peers, the report concluded.