Emerging markets blossom

The mature economies of North America and Western Europe continue to absorb vast amounts of institutional capital earmarked for the asset class. But emerging markets private equity is on roll as well.

As 2006 draws to a close, emerging markets private equity continues to be all the rage.

Within this fast-growing part of the asset class, much of the world's attention has been focused on Asia, where the world's largest private equity firms worked hard to establish themselves in the burgeoning markets of China and Japan, India and Australia. Home-grown Asian groups were similarly agile.

Equally telling has been the record level of investor demand for new private equity funds raised for all emerging regions: Asia, Central and Eastern Europe, The Middle East, Latin America and even Africa. By I November, according to data compiled by the Emerging Markets Private Equity Association (EMPEA) in Washington, fundraising for these regions was on track to surpass the $22 billion raised in 2005, itself a bumper year.

Attendance at Private Equity International's Second Annual Emerging Markets Private Equity Forum in London, which we hosted in late November together with EMPEA, was another sign that interest in the topic is at a peak. The sell-out event drew a crowd of 350 delegates.

Speaking at the Forum, Sarah Alexander, EMPEA's executive director, presented a wealth of statistics highlighting the momentum that the emerging private equity markets are currently enjoying. For example: drawing on new data compiled by Cambridge Associates, Alexander revealed “dramatic” improvements in average returns across the entire industry (see charts). Moreover, top quartile emerging markets funds outperformed the MSCI Emerging Markets Index for the first time ever, and they also outperformed US private equity funds for a third year running. These data points help explain why limited partnerships have been funding new emerging markets partnerships so aggressively of late.

Of course, one must not forget that this volatile part of the industry has disappointed in the past, and that there are big tests lying ahead. Although emerging markets private equity has grown deeper and stronger, it still accounts for only a fraction of the capital raised for investment in North America and Western Europe. Neither does it have anywhere near the penetration that private equity enjoys in the mature economies: in the emerging markets, according to EMPEA, private equity investment equates to just 0.21 percent of Gross Domestic Product, against 0.85 percent in Western Europe and 1.22 percent in the US.

Moreover, legel protection remains weak in many of the markets in question; contracts are difficult to enforce; minority share-holders rights and bankruptcy protection are far from robust; and corporate governance standards are still lagging those that investors are taking for granted in Western markets.

And yet: the widespread optimism prevailing around emerging markets private equity at the moment is a source of inspiration to many. As the articles that make up this PEI Special confirm, emerging marker funds the world over are drawing on significant LP support in their efforts to create profitable, internationally competitive investment businesses that are built to last.

According to industry veterans, there has, quite simply, never been a time like this for the industry outside its Western home markets. Yes, the challenges facing emerging markets private equity are formidable, and the current boom could prove short-lived once again. At this point, however, many are betting that it won't. The enthusiasts believe the industry will endure. As is private equity's went, they will need patience to find out whether their confidence was justified. But if the current vintage of emerging market funds delivers the goods, their managers' place in institutional allocation models could for the first time be secure.