Local or global?

In a world where more LPs seem to be accessing emerging markets through local managers, do firms with global footprints still have any sort of competitive edge?

In May, PEI revealed that after almost two years on the road trying to raise a $3.5 billion fund, UK-based emerging market specialist Actis had reduced its target to $1.6 billion and changed the investment structure of the vehicle.

The firm had initially targeted $2.2 billion for Actis Global 4, plus additional region-specific investment vehicles for India, Africa, China and Latin America, which brought the overall fund target to $3.5 billion. Actis has now consolidated the regional vehicles into the main fund – apart from the Africa side pool, which has a $200 million target (although that’s more like a co-investment vehicle which enables the firm to do larger deals).

“We have purposely changed our strategy and believe a global fund is more beneficial,” says Peter Schmid, head of private equity at the firm. “Emerging markets are volatile and there’s always a risk that too much capital is flowing to one specific region. In Brazil, for instance, $10 billion has been raised in the last 24 months. We truly believe that a global fund provides much more flexibility and reduces the risks of operating in an overheated market.”

The firm doesn’t want to be forced to do a number of investments in a region if it believes the timing isn’t right or the opportunities aren’t there. “India is a case in point – it was expensive in the past few years [so] we underinvested. Most LPs don’t want to be locked into India or Brazil for 20 years and they welcome this new strategy,” he says.
Some investors do, certainly. “I love the edge they can get from having people in all of the big emerging markets to swap notes on deal trends, macro issues, management stuff and so on,” one LP told PEI recently.

In May 2012, Capital International closed its sixth emerging markets vehicle on its $3 billion hard-cap, showing that global emerging market funds haven’t completely fallen out of fashion. 

And there’s still an argument that global groups may be better placed to help national champions expand beyond their country borders, and to find synergies between portfolio companies in different regions. They also make it easier for LPs that are newer to the asset class to get broad exposure to emerging markets.

We truly believe that a global fund provides much more flexibility and reduces the risks of operating in an overheated market.

Peter Schmid

However, the more experienced LPs tend to develop firm views about where their capital should go. “If you want to invest in Africa, and you back Actis, then you have to deal with their global fund and some people don’t want to do that,” says one LP source. “LPs [have specific ideas about where they want to invest, so they] put together their own global portfolio.”

“Investors may have originally invested in Actis to get a training course in emerging markets [before going] into the local market,” suggests another source.
Competition is certainly increasing. In Africa, for instance, big firms like The Carlyle Group have been tapping into the sub-Saharan region, while funds of funds have been establishing emerging market strategies.

And as local markets have matured, LPs have started to commit more money to local GPs. In 2008 and 2009, global funds raised roughly the same for investment in emerging markets as local managers, according to PEI’s Research & Analytics division ($34 billion vs $38.6 billion in 2008; $16.5 billion vs $16.4 billion in 2009). But in both 2010 and 2011, global GPs raised $18.7 billion for emerging market funds – while local GPs in those markets raised $31.4 billion and $56.3 billion respectively. While the gap narrowed slightly last year ($32.3 billion raised by the local GPs, $20.8 billion by global GPs), local competition is here to stay.

This has made LPs more demanding. In the case of Actis, one source argues that the firm “hasn’t done a particularly good job in showing their cross border strategy works … It’s not good enough in today’s market to be an allocation filler – there are too many GPs and you have to show that you are able to outperform because of your strategy.”

Actis’ previous fund, Actis Emerging Markets III, which closed on $2.9 billion in 2008, was generating a 1.2x multiple and a 7.5 percent internal rate of return as of Q1 2013, according to a market source. As of 30 September 2012, the firm’s prior Africa side pool was producing an 18.2 percent IRR and a 1.54x multiple, according to the California Public Employees’ Retirement System, while its Indian side vehicle was generating a 2.2 percent IRR and a 1.03x multiple.

Peter Schmid

“Every LP is different and they all make different decisions. Fund of funds, for example, have specific needs. However, we do think that we can attract some of the US state pensions or sovereign wealth funds with this model, because [it] enables LPs to write bigger cheques,” says Schmid, who emphasises that the strategy change has been supported by larger LPs looking for a diversified portfolio.

As of January, Actis had collected approximately $1 billion, according to a US Securities and Exchange Commission filing. So some investors clearly do buy into its proposition. But if it wants to get to that $1.6 billion target, it will need a few more of those big cheques.