Many institutions have climbed the Global Investor 100 ranking, but none has done so as dramatically as the International Finance Corporation (27). The development finance arm of the World Bank rose 50 places with its private equity allocation growing from $4.18 billion in last year’s ranking to $11.7 billion this time around.
A key driver of this is the outsized impact that covid-19 has had on emerging markets. According to a June 2020 report by the Organisation for Economic Co-operation and Development, private inflows into developing economies could have dropped by $700 billion in 2020 compared with the previous year (final figures are not yet in). This shortfall, OECD says, can only be made up by “co-ordinated policy responses across all sources of the finance mix”.
IFC quickly shifted from an offensive mindset to helping rebuild markets, preserve jobs and enable long-term private sector growth. “We are focused on re-equitising firms that suffered during the pandemic,” says senior director Bill Sonneborn. “We expect to materially increase the amount of investment in private equity as a result.”
IFC invests in private equity directly and through funds. Its direct investments focus on infrastructure, financial institutions, manufacturing, agribusiness, the service sector and disruptive technologies. Most of its fund investments are with growth and venture capital managers, and it has ramped up its co-investment activity in recent years, Sonneborn says.
The organisation’s selection criteria is to invest with “experienced, high-quality, locally based teams” that deliver development impact and profitability. This encompasses a broad array of funds, as illustrated by the commitments it has made so far in 2021.
In May, IFC committed $10 million to Endiya Partners Fund II, a VC fund focused on the early-stage technology, healthcare and consumer sectors of India, according to Private Equity International data. It committed the same amount to Knife Capital Fund III, a fund targeting early stage, high-growth South African companies. Other niche managers backed by IFC include Faering Capital, a life sciences manager focused on India, and Revo Capital, an early-stage venture firm targeting Eastern Europe and Turkey.
At the other end of the scale, IFC wrote a $100 million cheque for Cerberus Emerging Market Special Situations Fund, a $500 million fund targeting stressed and distressed credit opportunities mainly in Latin America and the Caribbean. It also invests in more mainstream buyout offerings, committing $50 million to India- and Southeast Asia-focused Everstone Capital Partners IV.
“Our experience has shown that some of the best opportunities come from motivated teams who are spinning out or have a blend of team experience ranging from PE investing to operational backgrounds,” senior investment officer Jennifer McLeod Petrini told Private Equity International last year.
Last year IFC took a close look at the impact the pandemic has had on the managers in its portfolio. The results were worrying. It found that demand shocks, reduced income availability and disruptions to supply chains were affecting sectors particularly popular with emerging market private equity firms, such as urban consumers. Government support is often unavailable to businesses in these countries, putting the onus on the fund managers themselves to find emergency liquidity. Exchange rate volatility, a returns killer even in good times, has also increased.
“A common sentiment among LPs and GPs… is that PE funds’ returns will take a hit in terms of reduced distributions to paid-in-capital and net internal rates of return,” IFC concluded.
Weaker returns create a more challenging medium-term fundraising environment. Several firms have lowered their targets, and LPs are backing out of emerging markets or reducing their commitments, IFC found. It is even tougher for VC managers. Their assets tend to require more follow-on funding and they rely more heavily on non-institutional investors that are often the first to step back when times get tough.
This is especially frustrating as emerging market fundraising was beginning to recover after a difficult 2013-17, when currency devaluations and concerns around exits caused investors to withdraw. In 2018, 18 percent of PE capital raised globally went to emerging markets, rising to 19 percent in the first half of 2019 – the largest proportion since 2012.
The shrinking of the private investor base means that funds targeting the small and mid-market will struggle to survive while larger funds, which may have stood on their own two feet, will need greater support from development finance institutions, IFC believes. The entire lifecycle – from fundraising to deployment to exit – will take longer, maybe a lot longer.
Sonneborn remains sanguine. “We are accustomed to operating in macro environments that can be unpredictable,” he says. “What we have learned over the years of investing is that our tendency to invest counter-cyclically has led to some of the better return outcomes.”
Amid the firefighting, there are opportunities. Emerging markets are experiencing the same mega-trends, such as the localisation of supply chains, digital transformation and the increased appetite for impact-oriented investing, as developed markets. The effort to fortify the world against future pandemics also creates opportunities in areas such a healthcare and biotechnology.
To help managers harness these trends, IFC envisages taking on an expanded role. It has noted a desire to increase its provision of working capital loans for businesses, carry out due diligence work for international fund managers with no local presence, and build bridges between local investors and fund managers to increase the pool of capital available for small businesses.
“IFC’s participation in the emerging market PE funds industry has been fundamental to its growth,” Sonneborn says. “[It] should continue to play a pivotal role in the industry, particularly at a time when fundraising has stagnated across several key EM regions.”