Despite the growing turbulence, the region’s PE industry posted one of its strongest years on record, including the highest year ever in terms of deal value and count. Yet the obvious question remains: Can the region’s breakout momentum over the last two years continue?

Bain & Co, a global management consulting firm, has released its third annual “Asia-Pacific Private Equity Report”. Its highlights follow.

lDeal value rose by a staggering 44 per cent last year, setting an all-time record of $125 billion – about twice the average of the previous five years. After surging 194 per cent in 2014 (following a worrisome two-year decline), deal value in greater China grew another 56 per cent last year to $69 billion, accounting for about half the region’s total. India and South Korea also posted record deal flow, while activity ebbed in Southeast Asia and Japan.

lDeal count shot up 34 per cent to 955, breaking through the 900 mark for the first time ever. For the second year in a row, greater China (the mainland, Hong Kong and Taiwan) led the charge in both value and deal count.

lAverage deal size set a new record, ballooning to $131 million, 45 per cent higher than the five-year average.

lAcross the region, exit activity at $88 billion remained robust, even in the face of extreme volatility in the equity markets. Greater China drove more than half of the exit value in the region, spurred by several large-scale initial public offerings.

“Last year was an exceptional year for deal-making. By comparison, 2016 will likely be much softer,” said Suvir Varma, who leads Bain’s private equity practice in the Asia-Pacific region. “As the macro story across the region deteriorates, PE is wading into unfamiliar territory – a slower growth environment that will make it much more difficult to find good companies, improve their performance and exit them at market-beating returns.”

2015 PE trends

Bain found that a surge in mega-deals (larger than $1 billion in value), particularly those in China and South Korea, accounted for 43 per cent of total transaction value across the region, more than double the value of a year earlier. Behind this surge were:

lPublic-to-private buyouts, which soared to $17 billion in value – more than three times the five-year average – and made up 14 per cent of total PE deal value in 2015.

lStrong activity among large institutional investors and sovereign wealth funds, which have long shown keen interest in the Asia-Pacific PE market. SWFs and institutional investors co-invested with traditional PE funds in 74 transactions representing $36 billion in value last year.

In terms of sector trends, the Internet sector was by far the hottest area of focus in the Asia-Pacific region in 2015. Companies offering Internet-based solutions are exploding, generating a groundswell of interest among PE funds looking for growth. Investors across the region plunged a record $36 billion into 371 Internet-related deals in 2015 and another $15 billion in 141 technology companies.

The opportunities ahead

Of particular note, this year’s report includes results from a Bain survey of 125 private-equity executives in the Asia-Pacific region on their three-to-five-year industry outlook.

Respondents point to China’s economic deceleration as the true test for the PE industry’s resilience and creativity in the coming year. Market turbulence in the Asia-Pacific region, characterised by slower growth, new economic drivers and greater regulatory uncertainty, will also heavily influence the current PE landscape and challenge the ability of general partners (GPs) to decrease their risk while still realising strong returns.

“How the PE market unfolds will differ based on where in Asia-Pacific one is looking,” Varma said. “The stories won’t be the same across geographies and sectors, which will require funds to abandon their one-size-fits-all strategies to identify profitable opportunities.”

As volatility and competition mount across the region, Bain’s survey revealed an increasing number of GPs reacting to the changing landscape in a variety of ways:

lBroadening focus – A trend towards geographic and asset-class expansion has been building for several years as firms try to expand their scope to limit their risks. The Asia-Pacific region made up 44 per cent of closed funds between 2013 and 2015, up from 23 per cent between 2009 and 2012. About a third of the GPs in the survey said they invested in non-traditional asset classes and 45 per cent indicated they would be broadening their scope to include such investments over the next five years. As appealing as diversification might seem in an increasingly challenging environment, however, it can also pose a high degree of risk, especially for asset-class expansion, which typically offers fewer synergies.

lCo-investing with limited partners (LPs)- Co-investments are on the rise in the Asia-Pacific region and unlikely to go away. Last year, co-investment deals made up nearly $36 billion of the total $44-billion deal value that involved LPs – a spike from just about a third of 2014’s $12 -billion value. Nearly 95 per cent of GPs expect the trend to continue or stay broadly the same in 2016.

lControl – Buyout deals are gaining steam in the region as PE firms seek more control over portfolio companies. According to Bain’s survey, 75 per cent of GPs said they expect buyouts will make up more than 80 per cent of their portfolios over the next two or three years versus 50 per cent for growth deals. In parallel, GPs also expressed their intent to gain more control, even when they sign growth deals with minority stakes. PE funds expect that almost 50 per cent of the portfolio companies they acquire with a minority stake will give them the ability to participate in critical company decisions within the next two to three years, versus 39 per cent today.

lActivism – As growth ebbs, it will become proportionally harder to create value without making significant changes to a portfolio company’s operations, management team and strategy. The power to exert such influence has often been missing in the Asia-Pacific region. Although 58 per cent of the GPs in the survey said they put in place robust value-creation plans for 80 per cent of their portfolio companies, only 14 per cent said they believe they are executing successfully on those plans.

Thriving amid uncertainty

Looking at the top funds in a difficult macro environment, Bain finds that the winners in the Asia-Pacific region share three broad characteristics:

lThey have storm-proofed their portfolios by dialling up their focus on portfolio activism, investing heavily in the people and capabilities needed to maximise the value of their highest-potential companies and generate the most compelling growth stories upon exit.

lThey are sourcing from a position of strength by targeting the most resilient sectors, sharpening due diligence to anticipate potential downside risk, and devising early, robust strategies for margin improvement, incremental revenue growth and exit planning.

lThey are reorganising inter-nally to devote more talent and resources to fixing companies. |They are also adding depth to in-vestment-committee processes |by including specialists and others |in the portfolio-review process, while creating stringent guidelines to focus resources where it matters most.

“PE funds will need to be well equipped to thrive in tumultuous times,” Varma said.

“The most successful of the pack, regardless of geography, share one key trait: They quickly transition from thinking as acquirers to acting like value creators. The clarity of their insights, the quality of their due diligence, and the discipline with which they price assets all represent the first steps in mobilising the right value-creation strategy and executing on it.”