LPs’ shifting outlook

A new survey shows a growing portion of institutional investors intend to invest in emerging markets in coming years. Judy Kuan speaks with EMPEA’s executive director Sarah Alexander on the drivers for investors’ changing attitude.

Last year, investors demonstrated their increasing appetite for emerging markets private equity funds, funnelling a record $21 billion into funds that will invest outside of fully developed economies, up 3.5 times over 2004 figures. Just released this week, the results of an LP survey commissioned by the Washington DC-based Emerging Markets Private Equity Association (EMPEA) provide further evidence of investors’ growing interest in and shifting mindset toward emerging markets.

Alexander: emerging markets are gaining traction among LPs

“This survey confirms that the emerging markets private equity asset class is gaining traction,” EMPEA executive director Sarah Alexander was quoted as stating in a press release. “LPs across a broad range of categories and countries are investing in these markets, or studying them and making plans to invest.”

Speaking to PEO, Alexander highlighted some of the less expected findings of the survey. For instance, she notes that, of the 76 institutional investors responding to the survey, 79 percent either agreed or strongly agreed with the statement, “Emerging markets are growing and changing quickly, so past returns are not a good indicator of average future performance.”

This finding is a stark contrast to the results from the first LP survey conducted by the association two years ago, which concluded that the main obstacle to LPs’ increasing their allocations to the asset class as being past underperformance.

“Today, past returns no longer seem to be the major impediment,” observes Alexander, while noting that this new attitude may in part be driven by the significant amount of cash that has been returned to institutional investors in the last two years. Alexander allows that two years does not make for a sufficient track record, but points out investors appear to see a recent maturation of the industry that suggests to them that short-term rather than 5- or 10-year returns are more indicative of future performance.

Alexander also highlighted that, in contrast to general market assumptions, concerns over how greater competition might drive down returns in other markets do not seem to be a significant driver for more institutional money being directed to emerging markets private equity. The EMPEA survey results suggest that there appears to be a low level of correlation between LPs’ interest in emerging markets private equity and the expected returns for commitments made to US buyout funds in 2005 and 2006.

“These results bode well for the sustainability of investor interest in emerging markets, but I would also caution that this is the beginning of a significant upturn in the cycle. It is way too early to tell whether this will be sustainable,” notes Alexander. “With record funds raised last year and all indicators showing that those records will be broken this year, it does raise some concerns about the bankable deals that are available.”

It is clear that more investors are currently giving emerging markets private equity the benefit of the doubt, particularly on the point of past performance. However, “returns do matter,” says Alexander, and they will influence the staying power of emerging markets’ appeal to institutional investors. It will be interesting to see how investors respond in a few years, as a longer track record of performance is created.

The full survey results can be viewed at www.empea.net