Six years ago, David Wilton was appointed private equity portfolio manager at the International Finance Corporation (IFC) to conduct a strategic review of the World Bank subsidiary's legacy of private equity partnership interests in developing markets. The fund interests had underperformed the organisation's direct investments by some distance, Wilton relates, and “we had to get on top of them”.
The first question that sprang to mind, he says, was “can we sell them”? The answer was a resounding no. “No-one was interested at all,” he recalls. “Secondaries investors just didn't want emerging markets exposure. Occasionally they would buy into emerging markets as part of a bigger portfolio and the emerging markets element would get priced at virtually zero. We began to think maybe there was a gap in the market, that there might be someone interested in this space that we could sponsor. There wasn't.”
We began to think maybe there was a gap in the market, that there might be someone interested in this space that we could sponsor. There wasn't
With the possibility of selling ruled out of the equation, the IFC set to work “performing triage on the underperformers” in the portfolio. There were a variety of reasons for the disappointing outcomes, according to Wilton: some GPs were too inexperienced; country-focused funds often had too small a catchment area, meaning deal flow was scant; and certain managers had long since realised carry was unattainable and were happily stringing out the fees for as long as they could get away with it.
Reflecting on the experience, Wilton recalls. “We did a lot of cleaning up and many of the old funds are in liquidation now. We ended up being among the most active investors in these funds – others just left them alone.”
But now, says Wilton, the picture looks far rosier. Having decided to retain its fund investment strategy, the IFC began focusing its attention on identifying the best managers in each territory – something it had not done successfully in the past. The result of this, he says, has been a “big change in performance”.
ON THE LOOKOUT
This helps to explain why he is decidedly less keen to sell assets now among signs that global secondaries players have their sights firmly set on the suddenly fashionable emerging markets. As they look for a way in, the positions held by development bodies such as the IFC, the Netherlands' FMO and the Asian Development Bank look attractive. Not only are these organisations well respected and widely trusted, but they also tend to hold large portfolios of assets.
Gazing admiringly at his improving portfolio, Wilton appears to be in no mood to oblige the would-be entrants. “I guess the question is, “why would we sell?” You do it when there's a change in strategy or direction and you want to alter your portfolio mix. We don't face that situation right now,” he states.
So is that the end of the matter? Certain secondaries funds canvassed by PEI think otherwise. They cling to the belief that where the commercial and development imperatives of organisations such as the IFC are in conflict, the latter might prevail. One specific suggestion in this context is that the IFC and its ilk might sell assets in order to help develop the asset class in emerging regions by demonstrating to LPs the depth of potential liquidity.
This is a line of reasoning taken up by Scott Foushee, a managing director at New York-based AIG Capital Partners. Asked whether development organisations are likely to start divesting, he says: “My hunch is that debates are going on as to what they should do. Historically they have felt it's in the best interests of the industry to be holders of last resort. That was pretty sound at the time. But now that some of these markets have become well established, they can make a bigger contribution to the next phase by demonstrating liquidity. We've seen no major sales from this source yet but over the next one to two years, I think it will happen.”
Adds Tjarko Hektor, partner and head of secondaries investments at AlpInvest Partners in New York: “Development organisations will be sellers of assets over the next three to five years as the strategies of managers no longer coincide with their charters. Some so-called emerging markets are no longer emerging and capital will be redeployed to areas that still are.”
NOT ALL ABOUT LIQUIDITY
Wilton is not convinced that such arguments have weight. “It's true that you need to get more investors into emerging markets funds, but the likes of pensions and endowments are not driven by whether there's a secondaries market or not, but whether the asset class has a long enough track record for proof of concept.” He also cites currency risk and regulatory issues as factors that may loom larger in investors' minds when making investment decisions than the depth of liquidity.
Development organisations will be sellers of assets over the next three to five years as the strategies of managers no longer coincide with their charters. Some so-called emerging markets are no longer emerging and capital will be redeployed to areas that still are
This is not to say that development organisations would decline to act altruistically in situations where to do so would assist one of its GPs. Wilton points out that the IFC had originally subscribed for a $45 million (€35 million) allocation to Moscow-based Baring Vostok's latest fund, which closed on $400 million last year. Baring wanted to balance its desire to limit the size of the fund whilst at the same time diversify its investor base. In the face of strong appetite from other LP groups, Wilton says the IFC voluntarily scaled back its allocation to $10 million.
However, Wilton adds that he is cautious about “stepping out of the way” as a general principle. He urges against assuming that just because a GP is performing strongly and able to raise successor funds that the IFC's job is done. He says that LP allocations to emerging markets are far less consistent than in developed markets, as a result of which “good results don't necessarily cement your place in the investor universe”. He also refers to the sensitivity that surrounds the IFC withdrawing from any fund amid the possibility that such a move could give other investors the jitters.
Daniel Dupont, a director at London-based Coller Capital, says he appreciates the delicacy of such situations following Coller's purchase of a portfolio of technology assets from the government of Quebec in March 2005. He relates: “The Quebec government had invested in venture capital in order to help develop the market in the early 1990s. By 2005, they felt the market had reached maturity and they should withdraw. But there were differing opinions as to whether they should do it or not and there could have been a lot of political fallout. They could have been criticised for pulling out because some people saw them as a direct long-term supporter of the industry.”
Such sensitivity makes withdrawal difficult. And in any case, Wilton reflects, why pull out when the going's good? He says: “In the 90s, the risk return wasn't attractive but we've come through and conditions are improving. Development organisations may be the most obvious pool of opportunities for secondaries buyers looking to get ahead of the game – but do we have a strategic reason to sell?” Only the passage of time will provide the answer to that: but the IFC for one doesn't appear to be in any particular hurry.