Asset allocation trends and the increasing interest in SEA venture capital
Year 2022 kicks off with investors focusing on inflation, interest rates, geopolitical risks and the tapering of QE. Many investors have been cracking their heads on how their portfolio allocation should change — from a tactical asset allocation perspective, many analysts have called for a rotation from growth to value, long volatility, and inflation assets. From a strategic asset allocation perspective, an interesting aspect to watch is with US 10-year yields back to pre-Covid levels, what are the implications for private markets and venture capital (which outperformed every other major asset class over the last few years, apart from crypto :P).
While many institutions continue to track private capital inflows and deal size/counts as the “end of free-money-effect” narrative unfolds, we would like to summarize and discuss several trends and themes we have seen and continue to see, and as much as possible, try to make sense of why there is increasing investor interest in SEA VCs.
- Institutional investors increasing allocation to privates
The past 2 years of QE and zero bond yields have caused investors to increase their investment allocations to alternative asset classes to achieve more effective diversification. For those wondering how exactly zero yields have diverted people away from a traditional 60–40 allocation between fixed income vs. equities and drove more capital into the bucket of alternatives, check out this nice paper written by Bridgewater: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere.
According to the OMFIF Global Public Pensions 2021 report, out of 101 funds surveyed, 72 either increased or held constant their allocation to private equity over the past year. The OMFIF estimates suggest that Canada’s CPP Investments holds the largest share of total assets in private equity, at over 23% compared to 19.5% in 2020. Texas County and District Retirement System also raised its private equity allocation to 21% from 16% the previous year, while Australia Future Fund increased its private equity allocation to 17.3% in 2021 from 14.4% the previous year etc. When the world’s largest pensions/sovereigns are heading in this direction, we can expect the non-government large institutional investors to be on the same path as they typically take higher risks for higher return.
With the Fed tapering and interest rate hikes in sight, the pressure in the stock markets should at some point trickle down to late-stage venture assets and there might be a reset of valuations at some point. But note all these do not seem to affect the optimism of investors in venture capital as an asset class in general. Unlike the dot.com bubble era, new technology is now recognized as a secular megatrend that cannot be missed out on in the long term despite the possibility of many short-term corrections. This is clearly evident as large investment managers such as Wellington are still recommending long fintech/enterprise intelligence and innovation, and the PEI’s Perspectives 2022 LP survey also highlights the bullishness of the majority of investors, with VC commanding more optimism. As such, we believe that investors’ increased allocation to privates should remain — and it is more of a question of when to pull the trigger and selecting what kind of GPs.
2. Free-money-effect and COVID environment resulting in greater competition among emerging managers
It is a known fact that the free-money-effect has led to strong capital inflows and buoyant fundraising market for PEVC GPs over the past 2 years. According to Private Equity International data, private equity funds raised US$415B in H1 2021, the highest since 2008. However, what is more interesting to notice is that with an increased number of emerging managers mushrooming into the market, combined with a lack of ability to travel and LPs’ natural preference to stick with reinvesting into existing GPs when it is harder to build new relationships without in-person contact — such dynamics have generated stiffer competition among emerging GPs in terms of fundraising. Perhaps with the survival of the fitness theory, emerging managers who manage to make it with a 2021–2022 vintage fund, could perhaps really be the gems among the stones. GPs with such vintage years could also be very attractive if combined with a sufficiently long commitment period and therefore the ability to be selective and deploy the bulk of capital post valuation corrections.
3. SEA VC an attractive segment, global investors developing relationships with SEA GPs
Southeast Asia could become the third largest tech hub globally after the US and China — it is home to a very sizable young population that is increasingly affluent and tech savvy. Supportive government grants and regulation, and healthy inflow of global capital has created a maturing venture capital ecosystem here. Mercer Alternatives published a paper in 2021, citing their views that Southeast Asia is estimated to be 5–8 years behind China and is expected to follow similar digital-growth trends.
From our own conversations with global LPs and various institutional investors recently, many have started building relationships with SEA VC GPs in 2021 and are ready to deploy this or next year. As China government’s policies started shifting to “common prosperity” and shuffled the fate of various tech sub-sectors, we have also heard from non-Greater China region investors that there is an increased tendency to shift some attention to SEA. While challenges such as having 10 non-homogenous local markets within ASEAN and a lack of depth to the regional talent pool remain, we are more excited than ever to be part of the ecosystem and contributing to its growth. In fact, we are proud to be a rare SEA early stage VC manager that is uniquely positioned at the intersection of being a multi-sector specialist and creating net positive impact by backing tech entrepreneurs who drive access and affordability to responsible financial services and healthcare in SEA.
Written by Melissa Chen, Head of Capital Formation & Business Development at Integra Partners.