Alternative Funds in Japan: an Overview

Despite a significant drop in fundraising regionally, due in particular to the steep decline in non-RMB denominated China-focused funds, published figures for Japan-focused alternative investment funds show modest gains year-on-year across most asset classes from 2022 to 2023, and predict solid increases on a cycle-to-cycle basis, with the 2024–2025 cycle poised to exceed the record fundraisings of the prior 2020–2021 vintages.

Although government-backed and captive funds represent a meaningful portion of the approximately USD6.6 billion in capital raised to date in 2023 according to AVCJ, significant third-party capital was raised by sponsors that extended fundraisings commenced in prior years as well as traditional fundraising powerhouses, including a notable one-and-done fundraise early in 2023. Cycle-to-cycle, fund sizes have increased meaningfully in Yen terms, although posting more modest increases in US Dollar terms, with the Yen having depreciated by almost 30% against the US Dollar between 2020 and late 2023. With many of the larger Japan-focused funds either currently fundraising or set to return to the market in 2024, increased exit activity, continued government support for positive legal and regulatory reforms, and the continued weakness of the Yen, Japanese alternative investment funds look to continue to be a positive counterpoint to recent weakness in the China market.

Key trends in the current year include:

• increasing maturation and diversification of the industry;
• continuing tailwinds from a historically weak Japanese Yen;
• continued increase in fund sizes generally;
• more domestic general partners (GPs) entering the global market alongside global GPs focusing on Japan;
• increasing secondary activity; and
• significant interest in private credit solutions.

Maturation and diversification of industry

The alternative investment funds industry in Japan continues to mature and diversify. In addition to the diversification naturally arising from the increasing size of funds raised by some sponsors, there continues to be diversification in sectoral focus, strategy and returns. In the current cycle, at least eight firms seem poised to raise alternative investment funds with commitments exceeding JPY100 billion, with at least half of those on track to raise in excess of JPY200 billion.

Venture capital funds have also seen some increase in fund sizes, and an increasing number of funds are targeting special situations. A number of sponsors, including MPower and NSSK, have raised funds targeting ESG initiatives and regional impact investing, and overseas sponsors seem keen to take advantage of the weak Yen to focus on investments in the real estate, core, core-plus, infrastructure and hospitality segments. There also seems to be increasing interest in private credit solutions, retail and private investments in public equity (PIPEs).

More new GPs

The number of domestic GPs raising or planning to raise capital from non-Japanese investors continues to grow. In 2023, Endeavour United and Mercuria Investment Group raised their first buyout funds with capital from non-Japanese investors, and a handful of other buyout sponsors are poised to raise their first funds with capital from non-Japanese investors in 2024. In response to difficulties in raising and/or deploying capital for investments in the PRC, a number of regional pan-Asia sponsors have considered or begun pivoting to Japan, either through formal country-specific funds and investment teams, or through allocation arrangements with greater regional focus on Japan. This pivot is occurring across multiple asset classes, including not only buyout but also real estate, hospitality, infrastructure and logistics.

Secondary activity

Industry observers identified secondaries as one of the most promising sectors for Japanese alternative investments in 2023 and the sector did not disappoint. The first ever GP-led secondary transaction closed at the end of November, spotlighting the promise and utility of secondary transactions. The factors underpinning the recent increase in GP-led secondaries – including liquidity constraints, the creation of synergies across portfolios and the ability to crystalise profits – exist in Japan to a similar degree as they do in other jurisdictions, underlying the notion that Japan remains fertile terrain for the various types of secondary solutions.

The relatively small fund sizes in an industry made up primarily of small- and mid-cap sponsors and the complex structures of many Japan-focused funds, including the prevalence fund series structured as multiple independent parallel funds, may mean that non-traditional secondary solutions, including GP-led tender offers, smaller more tailored secondary transactions and other financing solutions, might be more likely to find traction in the industry. In any case, Japan seems poised for increasing secondary activity in 2024 and beyond.

Fund finance and private credit solutions

In addition to increasing use of fund-level financing, particularly in the form of subscription facilities to bridge drawdowns, there appears to be an emerging market for net asset value (NAV) facilities (ie, facilities to permit borrowing against the NAV of a fund’s portfolio) to bridge liquidity needs prior to the realisation of investments and for funds offering such solutions to private equity firms. Particularly with rising debt costs, economic uncertainty pushing back exits and making returns uncertain, and increased investor appetite for liquidity, potential private debt and private credit solutions providers have had a keen interest in Japan. The increasing diversity of asset classes also presents increased opportunities for private lenders, and it would not be surprising if a number of private credit and private debt funds are raised in 2024.