By Kiki Yang and Thomas Kidd

Courtesy of Bain 

Asia-Pacific private equity investors turned cautious in 2022 amid a difficult and uncertain economy. Deal value for the region fell 44% in 2022, ending two years of record investments. In Southeast Asia, PE deal value declined more than 50% for the full year, and it tumbled further in the first half of 2023, down 68% compared with the same period the previous year.

These results have left Asia-Pacific PE managers less optimistic about future returns than they were a year ago, according to Bain’s 2023 Asia-Pacific Private Equity survey. Asia-Pacific exits and fund-raising also fell sharply in 2022, with exit value down 33% year-on-year. In Southeast Asia, exits fell by 46%. 

Many conditions contributed to investor gloom, including slower economic growth, declining consumer confidence, falling manufacturing output, high inflation, and heightened geopolitical tensions. Macroeconomic weakness is now the No. 1 concern keeping the region’s investors awake at night, according to our survey.

Internet and technology, still the region’s largest investment sector, made up only 33% of Asia-Pacific deal value in 2022, the lowest level since 2017. Investors turned instead to defensive sectors that offer steady cash flow and lower risk, including advanced manufacturing and energy and natural resources. In Southeast Asia, the internet and technology sector lost share in 2022 to healthcare and financial services. 

But turbulent times also create an opportunity to outperform. In our experience, the best-performing PE funds follow a few key strategies during periods of economic uncertainty. The first is identifying recession-proof sectors and the top-performing companies within those sectors. They also use scenario planning as a vital tool to understand the range of potential outcomes for targets and portfolio companies. Finally, fund managers roll up their sleeves and help improve portfolio performance.

In the current economy, attractive sectors in the Asia-Pacific region include healthcare, business services, infrastructure, and technology (in markets outside of China). Medical services and pharmaceuticals have been resistant to recessions historically. In Southeast Asia, rising levels of income and broader consumer health awareness are stimulating the expansion of private healthcare businesses.

As companies confront labor shortages, many are turning to outsourcing. That’s creating investment opportunities in business services such as business process outsourcing, facilities management, and industrial and technology services. At the same time, the Ukraine crisis has increased transportation costs and disrupted supply chains, boosting demand for distribution and logistics, such as marine services. 

Winning PE firms identify the companies poised to outperform in attractive sectors. That approach ensures high-quality investments that should outperform through the economic cycle.

At the same time, assessing a target’s business fundamentals is even more important in a turbulent economy. PE funds in the Asia-Pacific region are no longer relying on multiple expansion to fuel returns. Two-thirds (66%) of Asia-Pacific GPs say solid business fundamentals and good cash flow are their top criteria in selecting deals now.

A set of winning factors can help investors spot companies with the potential for superior outcomes. Bain analysis shows PE deals that outperform have at least one winning factor to counterbalance possible negative macroeconomic developments. These include rapid market growth; organic sales growth in existing stores and rising market share; and expansion into new geographies, products, channels, or adjacent markets. Other winning factors are acquisitions that make a target more competitive, identifiable acquirers that ensure a viable exit strategy, and margin improvement of more than 20% during a five-year holding period.

In turbulent times, leading fund managers also revisit their portfolio plans. A poor macroeconomic climate may make it prudent to delay exits, for example. Companies suffering from declining multiples or deteriorating business performance are likely to generate lower-than-expected returns. At the same time, value creation becomes paramount. Leading funds focus on cost reduction, improving capabilities, and bold strategic moves.

Macroeconomic developments will continue to pose a greater-than-usual risk to company performance for the next 12 months and maybe longer. For investors, the challenge is to identify and focus on the few things that matter most for portfolio performance. Scenario planning is vital in uncertain times since the range of potential outcomes is much wider than most businesses anticipate.

Leaders are taking a fresh look at their portfolio companies to see if the current macroeconomic climate warrants a shift in strategy. Almost certainly, some assumptions that originally underpinned a value creation plan no longer hold true. When the economic outlook darkens, the best funds redouble their efforts to improve portfolio company performance. They monitor and manage cash on the balance sheet, grow the top line through commercial excellence, and increase margins by managing costs and implementing smart pricing strategies. That helps these winners prosper in challenging times.

Kiki Yang is a Partner and co-head of Bain & Company’s APAC Private Equity practice based in Hong Kong and Thomas Kidd is a Partner at Bain & Company based in Singapore.