Grey is the new white: investing in Asia

18 March 2020

There are clear reasons why the smart money is shifting east, but as we found with Europe, this grey honeymoon is not indefinite, writes Julian Buhagiar

It is a truth universally acknowledged that an investor’s long-term success is based mainly on their risk strategy.

Let’s unpack this a bit. Broadly speaking, investments can be classified into three risk groups.

At the lower end of the risk spectrum, pension funds – the destination for pragmatists’ retirement – usually have between 5-10% of their management vested in highly volatile asset classes.

In the middle segment, there are specialist funds, particularly the emerging markets and derivates’ categories, which take on a significantly higher proportion (typically 20-30%) of larger-spread investments based on the promise of higher returns.

At the upper end, there is private equity and venture capital, and they have a wholly different approach to risk.

For instance, VC-based funds, where I spend most of my time (and money), price in an assumption that out of every 10 start-up investments, four will fail (hopefully with a sufficiently gratifying explosion), another four will just about return the original investment, and the remaining two will be stratospheric superstars.

So, at any one time, it’s safe to assume that at least 50-60% of PE/VC money is invested in high-risk assets.

Show me the returns
Here’s the clincher. Out of all these different investments, which asset classes have been recently delivering solid returns to their shareholders?

Not the pension funds, indeed in recent years many of these asset classes have been tracking way below standard stock market indices.

And this year – thanks in no small part to Covid-19 – carnage will be unleashed on stock prices that will be felt for the better part of a decade. Witness how many robust stocks – housing, defence, tobacco – are in decline this year.

If you’re thinking of retiring soon and living solely on a classic pension fund, it probably wouldn’t hurt to sit it out for the next few years.

Neither are specialist funds faring any better at present. Boutique asset classes, while seemingly defying gravity over the last few years, have found an Achilles’ heel when markets start to panic. In otherwise normal times, it makes sense to focus portfolios on less crowded niches.

Emerging markets, rare earth minerals, future lithium reserves: all were great topics of smug and savvy post-dinner digestifs along with the Armagnac.

But, as with all trends, they rapidly lose their edge once sentiment gravitates. Buy the rumour, sell the news indeed.

It doesn’t really fare any better with crypto-based investments, at least on anything more sophisticated than ‘hodling’ (storing bitcoins in a feverish-like belief that their real-world value will eventually reach the moon – no, me neither).

The recently announced crypto-funds, for example, attempt to stabilise the volatility in crypto-asset prices by locking them into longer-term well-behaved mixed asset classes; hence why most five-year crypto ETFs have predicted returns that are lower than the expected prices of their underlying crypto-assets.

But they are still classed (and indeed priced) as an uncertainty; whether bitcoin will be $200,000 or $20,000 in that investment horizon is anyone’s guess. Unless of course, you’re John McAfee, whose prospects of retaining his manhood are looking increasingly bleak...

So where is the investment edge with VC-backed funds? Most start-ups are not impervious to market shakers; indeed this year will be harder than most for many pre-profit based companies.

But quite a few funds have a few high-performing assets – some even unicorn potential – up their sleeves, and most of them are pointing eastward.

All points east
Why is there such a concentration of value in Asia at present? First off, this is not a trend specifically limited to gaming. From a business perspective, finance and especially tech have been investors’ destinations of choice in Asia.

Almost without exception, these early-stage businesses are replete with hard-working and strong ethic founders on minimal salaries and 18hr days, and no entitlement.

Also, when coming from Europe it’s almost impossible to comprehend the full potential of a market that is still nascent yet already orders of magnitude larger in opportunity.

Just one example to show how a crypto-based investment can be done properly. A Hong Kong digital asset platform has recently floated on the stock exchange offering full brokerage and futures pricing on most prominent crypto assets, and – importantly – backed by full banking liquidity.

In a few weeks, it is already worth twice its initial outlay. From an investors’ perspective, this is truly a goldmine.

From a gaming vendor standpoint, prospects are even more compelling. Faced with an over-regulatory stance in Europe, and a still-nascent market in the US, Asia feels like a refreshing industry for gaming money.

Still basking in mostly grey markets, and little to no incentives to go white anytime soon, it’s clear that there’s money to be made in the short-to-medium horizon.

Furthermore, no other continent boasts both the largest (Japan) and smallest (Vietnam) global player lifetime-values, together with similarly record-breaking proportional acquisition costs.

Get your LTV/CAC ratios right here, and talks of your investment fund returns will be the stuff of legends at your kids’ birthday parties.

Which is why practically most of the gaming stocks at the moment – especially, and somewhat counter-intuitively, the public players – have no qualms about broadcasting their activity in the East.

It seems strange that vendors and operators – Bet365, Scientific, Playtech, Gamesys, SBTech and NetEnt to name a few – that invest so much of their operating capital to ensure they fully comply with markets in Europe have no qualms reporting their quarterly takings from non-regulated markets.

And investors seem to be happy to take their dividends from these markets for the time being.

But the Asian-focused gambling start-up scene is possibly one of the most exciting areas of investment. There is an increasing number of very talented, Asian-specific content platforms that convert very high lifetime value players into long-term customers.

Couple that with a suitable acquisition and engagement narrative, and you have a very lucrative return on investment. That is where the smart money is currently at.

In retrospect, the reasons behind this broad shift to the East are clear. Faced with declining revenues (and increasing fines) from traditional old-world markets, any self-respecting fund will rapidly embrace any new strategy that diversifies profits and augurs medium-term growth.

Which is why legacy (read pension) funds are now replacing their recent chant of ‘gaming is bad’, and replacing it with ‘(Asian) gaming is bet-ter’…

Every silver lining
To every strategy, however, there is a downside. As with Europe, this grey honeymoon is not indefinite. That said, unless there is a concerted national and territorial effort to regulate, expect the process to be long drawn out and not without delays.

Witness how long it has taken Australia to regulate and is still a work in progress.

Naming and shaming, and/or IP blocking a couple of scapegoats won’t deter the market from the rest of the (now black) operators, and myriads of Curaçao-licensed platforms to supply content where there is ample demand.

Even here, this newly created black market will continue for the foreseeable future, albeit with declining revenues.

Thus, for the time being, focusing on Asia looks like a safe bet. But, as with all smart strategies, there should always be a diversified approach to investments. 

VCs, based on decades of hedged betting, tend to do this out of the box, and gradually we are witnessing this happening across other dynamic funds.

In the meantime, going long on stocks that are happy to increase their Asian exposure looks like a relatively good strategy. Which is, of course, deliciously contradictory itself, but such is the contradictory time we live in. Grey is indeed the new white…

Co-founder of RB Capital, Julian Buhagiar is an investor, CEO and board director to multiple ventures in gaming, fintech and media markets. He has led investments, M&As and exits to date in excess of $370m.