Friday Letter: Separating 'emerging' from 'emergency'

Investors are taking an increasingly pragmatic view of their investments in emerging markets. It's more about the manager than the market.  

One of the roundtable discussions at the 2008 Emerging Markets Private Equity Forum in New York yesterday focused on one of the most intriguing business environments in the world today: Russia. During the debate, one delegate posed some uncomfortable questions – what did the GPs active in Russia make of the “KGB duo” now running the country, did their rule equate to democracy, and wasn’t this something to be concerned about?

It was an important topic, replied a Moscow-based GP, but a topic distinct from the salient themes of the Forum. He had been assigned to discuss trends of primary relevance to private equity investments in Russia and Central and Eastern Europe, and the democratic credentials of Messieurs Putin and Medvedev were less relevant to the success or failure of these investments than were so many other factors.

There is a broader point underpinning this: as the so-called emerging markets are establishing a more permanent place in many institutional portfolios, limited partners are now far more likely to focus their concerns on things that GPs can control, such as manager screening, corporate governance and exit planning; they are altogether less likely to stumble over contingencies that GPs in these regions can’t control, such as sudden nationalisations, currency collapses and armed revolutions.

This evolving LP perspective was noted by more than one speaker at the Forum, co-sponsored by Private Equity International and the Emerging Markets Private Equity Association (EMPEA). When confronted with a new frontier, it is perhaps natural for an investor to first seek to learn as much as possible about the political risk, macro-economics and culture of the region before paying closer attention to the manager pitching the fund. But today’s emerging markets private equity opportunity is marked by two important features that are forcing LPs take a more advanced view: track records and globalisation.

The emerging market GPs who made it through the firewall of 1998 now have substantial investment histories for LPs to scrutinise. While not all these track records are stellar, at least LPs can see what the performance looked like through an emerging markets downturn. In addition, LPs have been confronted with stark evidence that, regardless of their current policies toward emerging markets investing, their developed-market portfolio companies, and almost every company in their public equities bucket, is inextricably tied to the emerging markets. It’s a fait accompli – the developing economies have already allocated to the Western LPs.

Likewise, one can hold a dim opinion of Team Putin and still decide to participate in the growth of the country it happens to lead. Losing money in Russian private equity is far more likely to be due to wanting manager selection than to Kremlin policy.