Limited partners chasing market stability are looking to invest in Japan’s private equity and venture capital ecosystems.
The country’s relatively predictable government policies against a backdrop of uncertain relations between the US and China, paired with a growing pool of aging business owners in need of succession planning, have fostered an environment primed for foreign investor participation in PE and VC deals.
In fact, from 2020 to 2022, investors from outside Japan were involved in an annual average of over 60% of PE deal value in Japan, according to PitchBook’s 2023 Japan Private Capital Breakdown.
The country’s stability is a key driver of investor demand for exposure to its markets, according to the report. Despite the global market slowdown, Japan is expected to remain on par with its PE and VC deal counts of the past four years—a product of capital infusion from the Japanese government to support private market players as well as growing foreign investment.
So far in 2023, Japanese PE players have generated $22.6 billion in deal value, the largest year for the country since its 2017 peak.
While potentially less lucrative than the buyout market, Japan’s VC ecosystem is also attractive to investors outside its borders. The country’s startup market is small compared to that of the US and China, placing a limit on the number of deals that can be done. As such, 54.5% of total Japan VC deal value involved foreign investors in 2022.
For LPs looking to diversify away from China amid geopolitical volatility, Japan offers an alternative way to gain exposure to the Asia-Pacific market.
China has seen clashes with the US, an economic downturn and a crackdown on its tech industry, leading US investors to pull back from China-based private market managers. From 2019 to 2022, for example, US LP commitments to China-based PE funds fell 56.4%, according to PitchBook data.
Meanwhile, Japan-based GPs said they have received an influx of inquiries from foreign investors looking to reallocate capital historically intended for investments in China, according to the report.
Still, the country’s private market ecosystem, which is small and localized relative to that of the US, hasn’t generated robust historical interest from foreign investors. While recent geopolitical events have sparked attention, most investors are still taking a “wait-and-see” approach, said Kaidi Gao, associate VC analyst at PitchBook and co-author of the report.
“Yes, there has been a surge in terms of increased interest, but I’m curious to hear how that translates into actual dollars getting deployed,” Gao said.
Gao said other countries, like Singapore and India, are in competition with Japan for foreign allocations. In fact, at the end of November, India overtook Hong Kong to become the world’s seventh largest stock market, according to data from The World Federation of Exchanges, illustrating investor confidence in the South Asian country.
An exit anomaly
While the rest of the world froze, Japan’s exit environment also remained intact. Q3 was one of the most active quarters on record for Japanese PE exit activity with 19 completed exits.
Additionally, in 2023, Japan generated its lowest investment-to-exit ratio since 2015. While the US will see a significant decline in PE exit count, PitchBook analysts expect 2023 to be a record year for exit count in Japan.
“Japan was a beta play from the macro markets,” said Kyle Stanford, PitchBook’s lead VC analyst and co-author of the report. “When the macro market is down, Japan is the better play than the US or somewhere else because those exits are still going to happen at a relatively strong cadence.”