This publication is grateful for these insights and invites readers, if they wish to respond, to get in touch with the editors. Feedback can be sent to tom.burroughes@wealthbriefing.com

Over the past two decades, a substantial amount of private wealth has been created in Asia. There are now a large number of newly wealthy individuals and families grappling with the problem of maintaining and growing excess capital.

There are numerous options for managing this surplus - including property, stocks and bonds - but, increasingly, Asian families are looking at placing a percentage of their wealth in investment funds. These can include private equity funds, hedge funds and real estate investment trusts. Current market volatility can make stable, long-term private investments appear more attractive.

Wealthy families and individuals often create family offices, which are basically private wealth management advisory firms, to oversee and manage their wealth. These family offices have traditionally allocated a larger portion of their total assets to private equity than other investors such as pension funds or foundations. Early indications are that Asian family offices are following and surpassing this trend.  

While the majority of such investments by Asian family offices will be made in established investment funds run by professional, international managers, we are seeing a significant portion going into funds managed by friends, family members or personal contacts outside of the big global banking institutions and private equity houses. This is partly due to the unique way business is conducted in Asia, a reticence to trust international advisers and a preference for placing funds where outsized returns may arise.

Often these new, independent funds are small and opportunistic and are managed not by seasoned professionals but by savvy businesspeople with strong local connections and networks. These funds are almost always private and funded by a handful of wealthy individuals and families. Lawyers specialising in family offices and high net worth individuals have an active role to play in establishing these bespoke new funds, acting for families or sponsors.

Cultural or generational?

Asian investors - especially those from first - or second-generation wealth - typically seek an active role in how their money is being managed and deployed. These investors have limited experience and trust in having third parties manage their wealth, and usually either own and operate their family business or did so until recently. These families are used to making all the decisions, and this attitude is reflected in their desire for control over how their wealth is handled.

European and American investors, in contrast, are more inclined to take a "hands off" view of capital oversight and often have generations of experience in managing their excess capital. Time will tell whether this contrast is cultural or the product of a large amount of Asian wealth being managed by the generation that created it.

Family offices in Asia also show a significant appetite for co-investing with funds, more so than their counterparts in Europe and North America. This investment activity is concentrated in industries where the families' wealth has been generated, and where families can use their experience and existing networks to identify high-quality opportunities. This can also benefit their co-investing fund.

For families investing in established, international investment funds, there is often little leverage or scope to amend or adjust the terms to ensure they receive a larger portion of returns ahead of management and sponsors, or have some say in investment or disinvestment decisions.

But for families investing in newer, smaller, private investment funds, there is significant leeway to shape the terms of their investment and the operation of the fund.

Generally, these new private funds are set up using a traditional private equity model, with sponsors or fund managers as general partners, and investors as limited partners. Significant limited partners can use their leverage to set terms with general partners that create a more favorable balance between management and investor interests.

Family offices will look to encourage management to earn their profit through carried interest and not through management fees and expenses. Asian families are often aggressive in seeking to limit management fees and expenses to estimates provided prior to the execution of subscription agreements and limit fees charged as a percentage of assets under management.

Cornerstone leverage

At the core of the relationship between limited and general partners is the distribution of revenue generated by the fund. After the return of capital contributed by the partners, a certain percentage of profit, called "carried interest" or "carry," is distributed to the general partner, traditionally amounting to around 20 per cent of the gains. Negotiable factors include the percentage of carry, when it is distributed, whether it is distributed after the limited partners have received a previously agreed upon rate of return, and whether it is distributed upon exit of each investment or based on the broader performance of all investments.

While management will seek the right to receive performance fees at an early stage in the fund life cycle, cornerstone investors will try to ensure profits from each investment remain available within the fund to offset future losses.

Cornerstone investors can also negotiate "side letters" with general partners to provide special terms and conditions, such as discounted fees, preferential liquidity provisions and additional investment capacity. These letters may include provisions that automatically provide these investors with benefits commensurate with those granted to other significant limited partners.

Asian cornerstone investors not only want improved returns, they also seek improved transparency and control. Activist Asian family offices seek positions on investment committees that oversee fund activities and seek specific decision-making powers over matters including conflicts of interest, valuation methodology and larger investments and disinvestments.

Some Asian family offices seek shares and board seats in the general partners, which are often offshore companies. While this will improve returns and access to information, it also increases litigation and regulatory risks for the investing family. If not structured properly, activist family offices could be seen by courts and regulators as part of management.

While partnership agreements and local law mandate a certain amount of financial information is provided to limited partners, significant investors can negotiate preferential information rights to better understand how fees are calculated and investments are valued. Managers and sponsors, however, will often resist these requests, with the argument that the information is confidential and could be used by competitors to set up similar funds or imitate trading strategies.

There are plenty of tools available for the prudent, activist investor. Cornerstone investors often underestimate the leverage they have to negotiate better terms. This leverage will likely increase as alternative sources of funds disappear amid market volatility, as occurred after the global financial crisis in 2008. Agreements are there to be negotiated, and substantial investors can investigate ways to adjust returns and increase levels of control and transparency over their funds.