When looking at funds focused in Europe, those that invest in Europe-based assets, “you can see that Luxembourg is slowly taking up quite a big portion of those funds as a domicile,” began Lai. “If we go a few years back, the proportion of Europe funds that are domiciled in Luxembourg, are maybe just still around like 20%.”
In 2015, the percentage of these funds domiciled in Luxembourg stood at 19%. This figure increased to 33% in 2018, to 42% in 2019 and to 53% in 2021. In 2022, 49% of Europe-focused funds were domiciled in the grand duchy. “So-called competitors,” like the Cayman Islands or Ireland, still have a “relatively small” share.
Regarding these Luxembourg-domiciled funds, “if you look at the asset classes, you’ll see the biggest piece tends to come from private equity,” explained Lai. But as a proportion of the whole, the private debt and infrastructure parts are “becoming bigger out of the total pie.”
Luxembourg funds have been positioned quite well for the private debt and infrastructure funds.
“What’s really good here is that infrastructure and private debt is actually relatively stronger than the prior year,” said Lai. There are opportunities here for the grand duchy. “Luxembourg funds have been positioned quite well for the private debt and infrastructure funds,” she added. “If these are the future growth drivers, Luxembourg is in a pretty good position to capture that growth, because these funds have already been set up there.”
If fund managers have a “good experience” setting up one or two funds, “then it is kind of natural for them to continue with their subsequent phases to set up there,” said Lai.
Focus on private debt and infrastructure
“2021 was kind of a record year where all asset classes hit their record highs,” noted Lai, “but then in 2022, because the macro environment is very different, fundraising, all the activities just really dropped, and some classes are affected more than others.” Private equity is one of the classes that was “really affected,” partly due to inflation and high interest rates.
In addition, real estate is “very sensitive to interest rates rising,” noted Lai, and investors view this as a key challenge. “But within all the asset classes, we see that investors are most interested in adding to private debt and infrastructure right now.”
Private debt has two advantages, said Lai. “First of all, a lot of bond investors see private debt as an alternative, because a lot of private debt exposure uses floating interest rates, which means that they are less sensitive to rising interest rates,” she explained. “Two, private debt tends to give a little bit of a better yield than bonds.”
It seems like everybody in the industry is really happy with Luxembourg as an ecosystem.
Investors are also interested in infrastructure because they get “some protection from inflation,” said Lai. “At the same time, you just see that there’s going to be demand--a lot of that is going to come from energy-related projects.”
In North America, many projects are related to the energy transition. “In Europe, you have this as well,” she added. “But one thing that has really come up on the priority list is energy independence,” which has been highlighted by Russia’s war in Ukraine.
“If these two asset classes continue to grow--and that’s sort of where we’re seeing--then it would mean that that’s an opportunity for Luxembourg to grow further in these two asset classes,” said Lai.
Key to maintain Luxembourg’s “ecosystem”
So why does Luxembourg remain so attractive? I asked Lai. “It seems like everybody in the industry is really happy with Luxembourg as an ecosystem,” she said, adding that the word “ecosystem” was heard very often during Alfi’s February conference. “In order for all this to work, you need to have the banks there, you need to have the lawyers, you need to have administrators there, you just need to have this ecosystem of different service providers to make it very convenient.” And Luxembourg has all that.
But it will also be important to watch out for variances in service levels. “We did hear a little bit of chatter, of sometimes, that service level may be coming down a bit,” said Lai. “And I think some of that is because it’s just growing--the industry has just grown so fast, so much, in Luxembourg. It kind of happens anywhere, when there’s suddenly a lot of growth, and then you have this problem of overcrowding, and then you start to have, like, more variance in service levels.” Maintaining that “very good ecosystem” is therefore quite important.
A second challenge relates to competition in Asia. “Asian investors are more open to Luxembourg funds. That’s great,” said Lai. “But Asia also has competitors--places like Singapore, places like Hong Kong also see this opportunity. And they also want funds to set up shop in their country.” The government of Singapore, for example, is giving cash incentives for funds to set up in the country. The environment will be “competitive” going forward, said Lai.
Interest in Southeast Asia and India
At the end of our interview, I asked Lai about any insights she might have regarding China’s re-opening after covid-19. In response, she presented the results of a survey that Preqin conducted in November, where Preqin asked people where they thought the best opportunities were in emerging markets.
“In recent years, China has always been the top destination,” Lai explained. “But you can see that it’s really come down in this last one. And it’s been surpassed by Southeast Asia and India.” 17% of survey respondents said that China presented the best opportunities in private equity in 2022, compared to 46% in 2021. Interest in Southeast Asia, on the other hand, has grown--55% of respondents said Southeast Asia presented the best opportunities in 2022, up from 50% in 2021.
“Since then, when talking to people, we’re even just seeing more headlines, as in like, very major investors in the region just simply saying they’re not going to add more allocations to China. So we haven’t seen that trend reversed just yet,” noted Lai. “The reopening really kind of just abruptly started end of last year, beginning of this year, and you can see that it still probably is going to take some time for things to settle down.”
“So I would say, right now, we can’t see that change in sentiment yet. It probably will take a while--it may not be this year, maybe next year. I would say that I would never rule out the comeback of China. It’s only a matter of time,” said Lai. “In the meantime, we see that people--if they have capital to allocate--they’re really asking about India and asking about Southeast Asia.”
This article was published for the Paperjam+Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link.