There’s a tendency to view emerging market investor bases as monolithic blocks with roughly similar characteristics. Latin America is perhaps the best example of why such broad-brush thinking is flawed.
The continent has some of the most sophisticated investors outside of Europe and North America: Colombian pension funds and Chilean family offices have been committing to global private equity funds for a decade and are now making moves into private credit. Then there are countries like Brazil, where LPs help fund a busy domestic private equity scene but have had little incentive to invest outside, and Mexico, where private equity investing of any kind has long been restricted.
For investors in the region, private equity has served two key purposes: helping them to meet their return targets, but also helping them diversify away from the natural resources sector, which dominates the economies and public markets of many countries.
Overall sentiment toward private equity is positive and growing more so. According to the 2018 Limited Partners Opinion Survey, published in September by the Latin American Private Equity and Venture Capital Association, 54 percent of the continent’s LPs expected to increase their exposure to private equity over the following 12 months. That figure was 46 percent in last year’s survey.
The biggest underused pools of capital are Latin America’s public pension systems, many of which are restricted from investing in funds that are international in scope. The past few years has seen changes that could help open the door.
In October 2017, the Chilean government laid out a framework for public pension funds, known as AFPs, to be able to invest in alternatives. It set an allocation range of 5-15 percent for eight different categories of alternative investment, including foreign private equity. It also made it so that international firms seeking to raise capital no longer had to go through a local feeder fund and were no longer obliged to employ a Chilean placement agent.
“It follows that recent changes in countries such as Chile, which allow for more investments in PE with less restrictions on structures, should help increase their PE exposure,” says Felipe Gazitúa, a Santiago-based director at private equity firm Altamar Capital Partners. “Some institutions have already taken decisive steps to strengthen their teams, increasing their capacity to analyse and potentially execute new PE commitments.”In January, Carlyle, Oaktree Capital Management and Intermediate Capital Group became the first international private equity groups to gain approval to seek direct investment from Chile’s public pension funds. These funds had around $180 billion in assets under management as of August 2017, according to law firm Baker McKenzie.
In Mexico, if private equity firms want to raise money from pensions, they have to go through a vehicle known as a CKD. These are effectively private equity trusts, traded on the stock market, bringing with them the usual burdens of public listing. At present, public pensions funds, known as Afores, cannot invest in CKDs linked to funds that invest outside Mexico.
In 2016 the government introduced the first CERPI, a vehicle designed to attract global asset managers. These entail the marketing of certificates to qualified institutional investors in a restricted public offering. For the time being Afores are excluded from investing in these vehicles and those CERPIs that do exist have been focused on specific infrastructure projects, rather than on pools of private equity assets. But there is optimism in the potential for CKD and CERPI to open up the market.
“There is an expectation that the Afores will be able to diversify internationally in the coming years,” says Cate Ambrose, president of LAVCA. “Every GP with an interest in emerging markets is looking at Mexico.”
In Brazil, the barriers to pensions embracing international private equity have largely been cultural and political. The pension funds are allowed to invest up to 20 percent of their portfolios in private equity and 10 percent of that can go towards funds that invest abroad.
However, the large public pensions typically would only invest with a GP if they got a seat on the investment committee, creating a conflict of interest that caused foreign private equity firms to stay away. There was also a tendency, according to May research by EMPEA, to pick GPs based on which offered the most competitive fees and favourable terms, not past performance.
Although the rules that govern this issue have not changed, pensions are beginning to align themselves with international norms, EMPEA notes, offering cautious optimism for the future.
“Lessons learned during the crisis will encourage local institutional investors to align with international LP standards by moving away from involvement in investment committees and improving their fund selection processes. These changes can help promote a more sustainable industry moving forward.”