Friday Letter Capital and legimacy

Increased opportunities in emerging markets are being acknowledged as a key ingredient to the further maturation of private equity. But in markets within Latin America and Asia, the industry's advancement also hinges upon domestic investors investing meaningfully in the asset class.

A series of high profile private equity professionals have recently made public remarks as to emerging markets’ increased prominence on the global economic stage.

Chip Kaye, co-president of Warburg Pincus, kicked off the sound bite bonanza last week at our Emerging Markets Private Equity Forum in London, declaring emerging markets at a “tipping point” in the global private equity landscape. Their “increasing macro-economic stability” and “increasing independence” clearly made them credible, and therefore critical, elements to this global private equity firm's plans.

Kaye singled out Asia as the region likely to throw up the greatest opportunity set, a sentiment echoed by The Carlyle Group's David Rubenstein speaking in Beijing Monday. China, in particular, Rubenstein said, was “by far the most attractive emerging market in the world” and, as its economy grows, the “Chinese private equity market will become the largest private equity market in the world”.

Limited partners are recognising these things, too. Globally, emerging markets are receiving a rising share in LP commitments. The $16 billion raised by emerging markets-focused private equity funds in the first part of 2009 represented 20 percent of the global fundraising market, according to the Emerging Markets Private Equity Association. To put that number in better context, emerging markets-focused funds only accounted for 5 percent of the market as recently as 2004.

This is all great news for local and global private equity firms, as well as the countries and companies their capital will support. But the importance of gaining greater backing from local limited partners cannot be underestimated.

In part, of course, their support is necessary for a host of fund managers to take part in the anticipated surge in deal activity, as “traditional” sources of capital – Western pensions, endowments and family offices – are not exactly expected to start writing big commitment tickets anytime soon. The Blackstone Group, for example, recently said it expects dominance of its limited partner base to shift away from North American LPs and toward “under-allocated” investors based in Asia and the Middle East.

But it’s not just capital that local LPs deliver to emerging private equity markets. They also bestow an important level of legitimacy.

Many private equity practitioners in Mexico, for example, are hoping the asset class will mature by leaps and bounds now that its Afores, 18 private pensions controlling hundreds of billions of dollars in assets, are being allowed for the first time to access the asset class via publicly listed vehicles. WAMEX Private Equity last week raised the first of many expected such funds.

If the Afores’ foray into private equity goes well, it will help “generate employment for Mexico and will generate an industry that doesn’t exist today”, said Joaquin Avila, managing partner of EMX Capital, a Mexico City-based Carlyle spin-out. As these pensions move into private equity, gatekeepers, advisors and other affiliates will spring up, strengthening the infrastructure needed to support a fully-formed and active private equity industry on the ground.

Couple this with the longer term impact of positive outcomes for pensioners, as well as for a broader spectrum of investee companies (not just prominent corporations, but SMEs, too) and you'll see the asset class become better understood and embraced by local regulators, politicians and the public at large – all of which is necessary to incorporate private equity successfully into a market's economic DNA.