EM markets investors must look beyond the headlines

The downfall of Abraaj Group, political risk and currency volatility have led to a less than rosy picture for EM fundraising this year.

It was a mixed picture for emerging markets private equity fundraising in the first half of this year. According to industry body EMPEA, Central and Eastern Europe and Commonwealth of Independent States had a 52 percent rise in fundraising, while that focused on Brazil more than tripled to $1.3 billion. Emerging Asia was the jewel in the crown, with a record $28 billion raised for the region.

At the other end of the spectrum, sub-Saharan Africa had a 9 percent drop in fundraising, while just $18 million was raised by one fund targeting the Middle East and North Africa.

“Investors have lost confidence in emerging markets private equity generally, especially for middle market opportunities outside of Asia,” says Gregory Bowes, co-founder and managing principal at emerging markets-focused investment firm Albright Capital. Strong returns for US private equity have added to the mix, causing some institutional investors to put a pause on deploying capital further afield.

“This has made life a little difficult for some groups in Asia,” says Brian Lim, head of Pantheon’s Asia and emerging markets investment teams. “There has been less of an incentive to seek further investments outside of their backyard.”

Public comparables paint a downbeat picture: the MSCI Emerging Markets Index, which tracks more than 1,100 companies across 24 emerging markets, is down almost 14 percent this year. Although emerging markets account for almost 60 percent of the world’s gross domestic product, institutional investors considering exposure to emerging markets face numerous challenges – perceived or real – including political risk, corruption and currency volatility.

The Turkish lira, for example, is down around 40 percent against the US dollar this year while the Brazilian real has lost approximately 14 percent. Such drops add to institutional investors’ worries about net returns.

“If I’m to convert distributions into US dollar net returns, it’s difficult to present that to my investment committee,” says Mounir Guen, chief executive at MVision Private Equity Advisers. “The currency volatility is really making it very difficult for one to compare apples to apples unless you are 100 percent convinced on having geographic diversity, which not everybody is.”

The downfall of Abraaj Group – once the darling of emerging markets investing – has been an unwanted distraction for firms attempting to raise funds in the region. Reports emerged in February that Dubai-based Abraaj had misused capital from its global healthcare fund, leading to a series of events including its founder and chief executive stepping aside. As of mid-November Abraaj was undergoing a liquidation process with firms including Colony Capital and Actis the likely buyers of some of its regional fund platforms, according to creditor documents seen by Private Equity International.

MENA-based market participants say the developments have undoubtedly affected the region. EMPEA, while not mentioning Abraaj by name, noted in its latest update that new funds “virtually disappeared” in the first half of this year amid “questions about the region’s corporate governance culture and investor safeguards”.

Neil Brown, head of Actis’s investor development group, says developments at Abraaj have not tarnished wider emerging markets.

“Abraaj’s issues are not about markets, they’re about governance. Most sophisticated LPs get that,” Brown says.

Actis has added nine new LP relationships so far this year, including some European pensions who are investing in emerging markets for the first time.

Macro issues

Still, headwinds remain. In an EMPEA survey conducted at the beginning of this year, LPs cited political risk as the factor most likely to deter them from investing in emerging markets within the next two years. Have issues such as trade disputes between the US and China or the election of a far-right president in Brazil caused LPs to reconsider private capital commitments to these markets? For some investors, such challenges may be too much of a cross to bear, Brown admits.

“Short-term volatility does affect some investors who are more thinking about when to put their toe in the water,” he says. Sophisticated LPs, however, that have multi-year programmes and have invested in emerging markets previously are continuing to do so.

Canada’s PSP Investments, for example, has between 15-20 percent of its private equity portfolio exposed to emerging markets. The pension is planning to open an office in Hong Kong next year and wants to “revisit” how emerging markets – particularly Asia – fits in its portfolio, according to Simon Marc, the pension’s head of private equity. It has relationships with around 12 emerging markets managers and wants to build a “broader portfolio of partners” across the Asia region, Marc says.

Ultimately, it’s important not to be swayed by current headlines, says Albright’s Bowes. Investors should avoid country-level decisions and should invest with managers who focus on management teams, underlying supply and demand conditions, interesting themes, and that carefully evaluate risks, and then use a thoughtful deal structure to mitigate those risk factors, he adds.

“If you do that, you’re going to gradually build a portfolio of some pretty good assets around the world.”