Investors still hungry

Times are tough for emerging markets private equity firms. Their largest fund supporters, in the form of big public pensions, are reeling from the denominator effect and have all but shut the lid on new commitments. They are writing smaller tickets, and even then are only backing their best and deepest relationships, which tend to be firms rooted in mature markets. And, at a time when even the safest of strategies can be susceptible to souring economic conditions, the risk associated with certain emerging markets seems amplified to many LPs.

Fortunately, that dreary scenario – while true for some – doesn't apply to all. Janusz Heath, a managing director with Swiss-based alternative investment manager and advisor Capital Dynamics, notes that there is no blanket reaction by LPs towards emerging markets.

In addition to those stricken by denominator problems and retooling their programmes, Heath says: “You'll also see LPs which may have been leapfrogging into emerging markets before building private equity portfolios in the more developed markets, which will look more cautiously and indeed pull their horns in.” Meanwhile, some of the “most experienced LPs – which have seen difficult markets in the past and understand the dynamics – will continue to diversify into emerging markets.”

Fellow Swiss alternative investment advisor SCM Strategic Capital Management, for example, is continuing to point capital towards emerging markets. The 12-year-old firm notes on its website it has an annual investment volume of roughly $1 billion.

“We are not slowing down our commitment pace. We continue building diversified portfolios which includes emerging markets funds commitments,” says Ralph Aerni, head of private equity for SCM. At present he estimates 5 percent to 10 percent of SCM's portfolio is in emerging markets, but expects that to double in the medium- to long-term as the markets become more mature.

Those are figures that some LPs would envy. Jan Terje Aasgaard, head of private equity for Oslo-based financial sevices group DBNor, will early next year ask his board to broaden his division's investment mandate to include emerging markets, perhaps with an allocation of as much as 10 percent. DBNor currently has roughly €750 million invested with Western managers, but Aasgaard sees great opportunities in growing economies like India and China. Aasgaard's attraction to Asia is characteristic of LPs at present – some 75 percent of all emerging markets private equity fund commitments made in the first part of the year were to Asian funds, according to the Emerging Markets Private Equity Association. Internal research from PEI Media confirms that Asia-Pacific funds are the most popular emerging market funds with LPs, followed by the Middle East and North Africa, Central and Eastern Europe and Latin America [see chart 1. p. 56)].

While Heath cautions that “high GDP growth does not necessarily correlate to a good institutional private equity market” – and that a slowdown from double-digit to singledigit growth, as projected for China, will indeed impact economies – he, too, is bullish on Asian prospects.

With the firm's “manager before the market” ethos in mind, he notes that the swell of private equity activity in Asia has given LPs more choice in fund managers, many of which have proverbial “scars on their backs” from past economic crises.

SCM, which tends to first enter emerging markets via global or panregional funds to avoid adding any initial “organisational risk” to the emerging markets risk, also tries to avoid groups in emerging markets that do well simply because stock markets have provided lucrative exit routes.

“We believe if you back a GP in emerging markets, you need to invest with a group that really drives operational improvement and operational growth and not groups which just rely on booming IPO markets,” Aerni says.

“Although it's going to be challenging in the next few years, I think it's also going to be a great time to back managers who are going to be the next generation of really great managers, just as in any of the developed markets,”Heath says.

A slew of emerging markets managers – many investing their first or second funds – have recently received votes of confidence from LPs. Asia Alternatives closed its second fund of funds on $950 million; China-focused FountainVest raised $1 billion for its maiden fund; Central and Eastern European firm Abris Capital Partners closed its debut fund on €320 million; and South Korean private equity firm STIC Investments closed its second secondaries fund on approximately $369 million.

The list goes on – which provides confidence that so, too, does LP appetite for emerging markets.