Determining the attractiveness of Latin America as an emerging private equity region rather hinges on who you talk to. Although most GPs and LPs readily agree that the environment for making investments in many parts of the region has vastly improved in recent years, the two groups tend to butt heads when it comes to whether it makes sense for investors to commit new capital to Latin American private equity funds at this time.
According to Roger Berry, cofounder and senior partner at Boston-based emerging marketsfocused placement agent Liberty Global Capital Services, there is some increased LP interest in having exposure to Latin American private equity – in large part generated by growing investor enthusiasm for emerging markets as a whole. “India and China have switched on LPs to emerging markets in general,” says Berry. “Now, the question for LPs becomes how to find the best managers in the best contexts.”
Adds Joncarlo Mark, senior portfolio manager of the Alternative Investments Management unit of the California Public Employees Retirement System (CalPERS): “When you talk about Latin America, it's clearly an emerging market, and it hasn't been a place that has seen a lot of success from an institutional standpoint. However, I think things are changing. The headline is that Latin America looks better today than five years ago. You see significantly more stability among the major markets and pretty good performance in public markets, and there is reason to believe that the macroeconomic risk has subsided.”
Unsurprisingly in light of these positive comments, CalPERS – the largest public pension fund in the US – has made commitments to two Latin America-focused funds in the last 18 months. One was Advent International's $375 million (€315 million) Latin American Private Equity Fund III – which closed in September 2005. The other is the $250 million fund currently being raised by Carlyle Mexico, which has also recently received commitments from the New Mexico State Investment Council and the International Finance Corporation.
However, it could be said that CalPERS is at the leading edge when it comes to gaining exposure in Latin American private equity. Many GPs active in the region are currently winding down existing funds and are in the midst of scouring the LP community for new capital. These firms include Carlyle Mexico, Baring Latin America, Deutsche Bank spinoff Conduit Capital Partners, Brazilian firms GP Investimentos and BPE Investimentos, as well as numerous funds with targets of less than $100 million being raised in various parts of the region.
As they proceed on the fundraising trail, a fair number of these GPs have found the path to be both time-consuming and tough. Some have been in the market for over two years, knocking persistently on LP doors – often finding that no response is forthcoming.
The reasons most often cited by LPs for declining to commit to Latin America funds tend to be threefold.
First, the region is still suffering from the underperformance of many first-generation funds in the region and from investor fatigue over macroeconomic upheavals – such as that seen in Argentina. Large pools of capital were funnelled into Latin America during the mid-1990s, then lost as many parts of the region suffered financial crises at the turn of the millennium. As a result, more than a few investors liken the region to a capital black hole. Investor perception is still clearly an issue that Latin American GPs must grapple with as they try to raise new funds.
A second obstacle is that many LPs do not have a slot for Latin America within their allocation to the private equity asset class, which means that GPs from the region must compete with other “hot” regions and products for capital. “Many investors will have a “rest of world” private equity allocation. The overall pile will grow, but teams from Latin America will not only have to make the case about their own credentials but also how their markets stand up to India and China,” says Liberty Global's Berry.
Thirdly, while the market has improved in Latin America, investors typically identify few changes in the region that make a compelling and urgent case for investing. “By and large, investors do not have a great degree of enthusiasm for the region, and they're certainly not giving policy makers the large benefit of the doubt that they're giving to those in China and in other economies,” says a source. “I wish I could paint a more upbeat tone for the region, but there's a pretty strong disconnect between investment prospects and investors' general perceptions.”
BUILDING A CASE
Despite these factors, there are some investors out there – CalPERS being one such example – that are acting on what they see as highly promising opportunities.
“Some of the reluctance on the part of LPs is starting to get shaved away as investors see the public markets in Latin America perform better. Some first-time funds are performing better, in part because public markets are performing better. That all goes a long way in addressing LPs' concerns,” says Jim Martin, a managing director in EMP Global's Latin America Group.
Investors are keeping a particularly close eye on Brazil and Mexico, often viewed as the economic anchors of Latin America. “The sophistication of local capital markets and local industries has really grown, and there is a lot more financial integration of companies in these countries with those in the US,” says Katherine Downs, a director in EMP Global's Latin America Group. “With that level of sophistication comes a more secure environment for investing.”
Both CalPERS's Mark and Frank Brenninkmeyer, a Stamford, Connecticut-based vice president on the international private equity team of GE Asset Management, concur that Mexico and Brazil are the region's most attractive investment locales at the moment. Mark notes that Chile is a good but relatively small market, while Argentina still has some macroeconomic issues to work out.
Mark adds that there could be some interesting investment opportunities related to the energy sector, particularly if the currently tightly-controlled state-owned enterprises in some countries end up being privatised.
Indeed, specialisation is a burgeoning theme in the region. Many funds entering the market are choosing to be more sector-focused, for example in technology, financial services, and environmental services. Plenty of GPs are also choosing to build funds that focus on particular countries, such as Mexico or Brazil, or specific geographic areas, such as Central America or the Andean region.
“One of the things we're seeing in Latin America now is that there's not the homogeneous story that you've seen in the past,” says EMP's Martin. “Each sector and each country is responsive to specific dynamics, in part because the political context in each country is changing, and the economic realities are different. As we look at Latin America, and I think most investors are doing the same, we are clearly differentiating among the countries and see great opportunities in parts of Latin America and other parts where we are less sanguine.”
HORSES FOR COURSES
For those LPs still keeping watch over Latin America, one key consideration is how best to go about accessing the region.
It is critical that global private equity firms find local teams to partner with
According to Wayne Harber, a managing director at Philadelphiaheadquartered investment advisor Hamilton Lane, the firm is more comfortable with backing GPs that have a pan-Latin American strategy than those that hone in on one particular country. “If you look at what's happened in Chile over the last few years, it is a very attractive market,” says Harber. “However, the private equity funds specific to the country are very small. Clearly there are opportunities, but this is why I would take a pan-Latin American strategy.”
Despite this preference for regional funds over country-specific funds, LPs want to see GPs building a local presence in the areas where they are investing. “It is critical that global private equity firms find local teams to partner with when investing in South America and other emerging markets. Such firms will offer local knowledge and a global perspective and network, which is a powerful value proposition for entrepreneurs to consider if they are looking for private equity capital,” says Mark. He points out that Advent and Carlyle have both established strong investment teams based in Latin America, allowing firms ready access to both local and global resources.
Another thing that LPs targeting Latin America seem to prefer is a later-stage strategy. “In Latin America, we think that the better returns are being generated on the larger side of the buyout market, even though the larger side is still smaller than that in Europe, North America or Asia,” says Harber. Mark agrees, and says CalPERS has little intention of engaging with venture capital funds in Latin America.
A further factor to take into account is that investors are seeking to back GPs and companies that are competitive relative to international – rather than local – standards. “We do not have a specific sector focus, but we look for deals with strong, well-incentivised management teams, the potential to be national or regional market leaders in their respective industries, stable cash flows, sustainable profit margins and defensible business models,” says GE Asset Management's Brenninkmeyer. “Consideration may be given to smaller markets, but those investment opportunities are not actively sought out.”
Brenninkmeyer adds that corporate governance and the political environment are also important, and that GE is careful to avoid investing in companies where family owners or government regulators can exert too much influence. “Some of these criteria were developed as the result of the past experiences of our [GPs] as well as our own direct investing,” he says.
Consideration may be given to smaller markets, but those investment opportunities are not actively sought out
The main point to highlight is that the underlying strength of any investment programme should be based on an attractive risk-reward ratio, say investors. “Clearly risk-reward is part of the equation. You've got to ask yourself what is the impetus for being there,” says Hamilton Lane's Harber, adding that there are a variety of ways for investors to gain exposure to viable Latin American companies without committing to a “fund-based approach”.
“It could be a fund based elsewhere with a team down in Latin America or maybe a follow-on investment for a portfolio company,” says Harber. “Most of the global players in private equity have people on the ground there. While they might not have a socalled Latin American fund, they are global in nature and are mostly opportunistic in the way they approach the marketplace.”
According to Harber, the firm has participated in Latin American direct investment funds on behalf of its clients, but the firm does not have a specific allocation for Latin American private equity at this point, and will continue to view the region on an opportunistic basis. Meanwhile, both GE's Brenninkmeyer and CalPERS's Mark say that their respective institutions will continue to invest in funds and deals in Latin America, but add that caution is key.
“Our board has demonstrated a willingness and appetite to invest outside of the US, but I think everything has to be done in context. We don't want to make a huge sector bet, and we have to be careful in how we approach the markets,” says Mark. “The primary vehicle for our previous presence in Latin America was The Exxel Group funds, and therefore the experience hasn't been that great. On the other hand, you learn your lesson and try to pick managers that have the characteristics I mentioned before.”
Many investors have “dipped their toes” in the region, as Harber puts it, though whether or not they will go on to invest in a meaningful way is not yet certain. However, most are tracking the opportunities available in Latin American private equity and might well take the plunge if the story becomes compelling enough. “You never say never,” says Harber. Not the most optimistic assessment of Latin America's private equity prospects perhaps – but in a region where investors have regularly had their fingers burnt, it will have to do for now.