Mexico FoF: Local LPs ‘eager to invest’ abroad

Mexican pension funds can only invest in domestic private equity funds under current regulations, but Felipe Vilá Gonzalez, chief executive of Mexico’s fund of funds group Fondo de Fondos, says LPs are keen to diversify abroad.

Mexican pension funds are keen to put their money to work in private equity funds that back companies around the world, says Felipe Vilá Gonzalez, chief executive of Mexico City-based fund of funds Corporación Mexicana de Inversiones de Capital, known as “Fondo de Fondos.”

Right now, however, Mexican pension funds are only permitted to invest in Mexican companies, via investment vehicles known as Certificados de Capital de Desarrollo (CKDs). Vilá Gonzalez, whose fund manages some USD $1.2 billion in assets, told Private Equity International that with capital invested in private equity by the Mexican pension funds growing at some 20 percent a year, he expects current regulations to change to accommodate investor demand for access to global private equity.

What investment strategy does Fondo De Fondos have with fund managers?

We look in the equity growth area and funds that invest in Mexico and other Latin American countries, such as Colombia, Peru, Brazil, Chile, and some Central American countries like Dominican Republic, Panama and Costa Rica. Sixty percent of our investment is in Mexico, while 40 percent goes international. [Effectively, Fondo de Fondos invests in Mexico and some Latin American countries. However, the Mexican pension funds invest in only Mexican companies through the fund of funds manager.]

We’ve also been active in venture capital, specifically in early-stage companies with a focus on technology and innovation. As there are not many VC firms in Latin America, we’ve invested with US fund managers who are willing to invest in Mexican technology companies. I would say 80-85 percent of VC capital is invested in Mexican companies and 15-20 percent in US companies.

We’re now performing due diligence on some VC fund managers in Brazil, Argentina, Chile and Mexico to expand into VC opportunities in Latin America. Argentina’s new president [Mauricio Macri, who won the election in October] is friendlier towards foreign investments. In Brazil, there are some technology sector-related opportunities.

How does the future look for Mexican pension funds that can invest in private equity only through CKDs?

It’s been cumbersome, but not too much. The main restriction is that the CKDs [Certificados de Capital de Desarrollo] can invest in only Mexican companies. If any international fund manager is willing to form a CKD, it would have to only deploy capital within Mexico. The CKD would exclude those Mexican pension funds from the fund’s other investments outside of Mexico.

But the Mexican LPs are eager to invest, having committed 200 billion pesos ($10.6 billion; €9.7 billion) to funds, of which 95 percent came from the pension funds and 5 percent from insurance companies. I would anticipate a rule change for CKDs due to the amount of capital growing at 20 percent a year. It’s growing faster than the investment opportunities. So, eventually they will have to change the regulations – I hope sooner than later.

To a foreign investor, what makes Mexico an attractive region for allocating private capital?

As an emerging market, we should be growing at 5 percent a year per capita, but we’ve been growing at 2-3 percent. But in Mexico, the economy is oriented towards industrial production and services, rather than commodities – about 15 percent of our exports is in commodities. Even if the economy doesn’t get to grow at the 5 percent that we need, it’ll keep growing at 3 percent because we don’t depend on commodity prices like other Latin American countries.

The Mexican demographics of the growing middle class also provides opportunities to invest in consumer-oriented sectors. Those opportunities will be there for a long time if you choose good fund managers, because they are growing faster than the economy, with domestic consumption growing at 5 percent per year. There’s a potential to generate strong returns without too much risk.

And with the energy reforms by the Mexican government, there are investment opportunities related to energy. When the price of oil started falling in 2014, people expected a slowdown of opportunities in the sector. But we launched a fund of funds at the end of 2014 to see if the [government] reform would work. We deployed $100 million so far, not in distressed. Mexico has the lowest cost of oil production among the non-OPEC [Organization of the Petroleum Exporting Countries] countries. Including OPEC, it stands at fourth.

How is the investment environment in Mexico, in terms of valuations, fundraising and exits?

Valuations in Mexico are not that high, compared with the rest of Latin America, the US and Europe. As measured in dollars, valuations are about 30 percent below of the amounts observed last year. Because of that, exits have been slowing down. But the rate of investment has increased and capital calls have been very active. Because of the strong dollar, people are trying to invest where the local currency is undervalued.

With that said, I don’t think the strong dollar against Pesos can last a long, long time. These outflows of capital from Mexico into the US would have to stop and revert at some point. Although what happened with Brexit [pushing up the dollar] doesn’t help, but it’ll happen eventually.