On the rise in a downturn

Is the glass half full or half empty? The classic test of whether someone has an optimistic or pessimistic nature applies rather neatly to emerging markets private equity at the current time. Take the two fundraising graphs (below and p. 32) for example. One shows emerging markets funds collecting 55 percent less capital in the first six months of this year compared with the corresponding period of 2008. The other shows 2009 as representing the high water mark of emerging markets fundraising relative to developed markets.

Sarah Alexander, president of the Emerging Markets Private Equity Association (EMPEA), adopts a positive slant: “The slowdown in emerging market fundraising and investment is consistent with, and generally less severe, than the decline in developed private equity markets. We are not seeing the sort of capital flight from emerging markets that followed past crises.”

The ‘relative strength’ argument is also put forward by Koenraad Foulon, private equity senior managing partner at Capital International, an arm of US fund manager Capital Group. “Emerging markets will continue to drive the world economy for the next two decades,” he says. “That's a strong statement but I remember vividly our first fund in 1992 when emerging markets' share of world GDP was 30 percent and their contribution to the world's growth rate was also 30 percent. Today, emerging markets' share of GDP is 45 percent and the contribution to the growth rate close to 70 percent. I believe that this trend will accelerate.”

There is also what might be termed the ‘absolute’ argument, as neatly encapsulated by George Siguler, managing director and founding partner of Siguler Guff, the New York-based emerging markets investment specialist: “Nobody's better off. Emerging markets are not as strong as they would have been if the crisis hadn't happened.”

At the recent Emerging Markets Private Equity Forum, staged by PEI and EMPEA in London, much consideration was given to whether emerging markets have ended up in a good or a bad place in the wake of the most dramatic global financial and economic upheaval since the Great Depression.

Tom Gibian, chief executive of Emerging Capital Partners, the Washington DC-based African investment specialist, feels that emerging markets now find themselves in a strengthened position: “Hands down, emerging markets are coming out better. Many of these markets have realised that allowing the private sector to be the engine of growth creates a more stable political situation that builds economies, perpetuates power and brings people out of poverty. There has been a ‘buy-in’ to the private sector that wasn't there 20 years ago.”

However, reflecting that the post-crisis landscape is a complex one, Gibian qualifies his optimism in the following way: “There was a view that ‘next year will always be better’. That view has gone and, when you break that paradigm, there are all sorts of implications. The committable resource is scarce, and, if you don't know whether next year will be better, you might have to conserve cash. Stability is emerging, but at a new level where money is more expensive.”

One of the challenges of assessing the “emerging market” experience is that it is a wide umbrella term that covers markets with very different traits and at very different stages of development. Richard Laing, chief executive of UK governmentbacked fund of funds manager CDC, posed the philosophical question, “What is an emerging market?” before adding: “We have different views of South, West and East Africa. And Eastern Europe is certainly very different from Brazil. You've got to be very intelligent as an LP in terms of which ones to be in.”

There was a broad view that there are three markets investors simply cannot afford to ignore in the long run: China, India and Brazil. These are markets which, because of strong demand from their domestic markets, are seen as increasingly independent from global developments. The selfconfidence of China was reflected in its bold response to the crisis, according to Charles “Chip” Kaye, co-president of global investor Warburg Pincus: “China's fiscal stimulus drove at full speed into the headwinds. For a while growth declined – but now, the worries are once more focused on overheating and inflation.”

He added that China offers “the most significant long-run investment opportunity for investors”, noting, however, that it had not been an easy place to invest in the past, and this would not change in the near future due to the regulatory complexity surrounding investments.

Adds Foulon: “I see a very good opportunity in China. In the long term it will be a global player and everyone has to wake up to that. There will be challenges for investors. But, in the discussions we've had in China, it's clear that there are a lot of entrepreneurial people willing to adopt the best corporate governance practices. That was not the case around 15 years ago. ”

Many of these markets have realised that allowing the private sector to be the engine of growth creates a more stable political situation

It is interesting to note from EMPEA's figures that “emerging Asia”, a category including China and India, accounted for more than $11 billion of the total amount of just over $16 billion raised for emerging markets private equity in the first half of 2009. The frequently expressed positive sentiment towards Africa and Latin America in particular is not yet reflected in the fundraising figures which show emerging markets allocations continuing to gravitate to Asia.

With Asian private equity now well rooted, investors are perhaps more confident that risk factors can be more easily calculated in Shanghai than they can in Lagos (to pick a random example). Given the structural failings in the Western banking system, a reassessment of developed versus emerging markets risk is – we are told – high on investors' agendas. Nonetheless, it will likely be some time yet before the dealdoing process is considered to be as straightforward in the emerging as in the developed world.

“One of the key things to consider is quality of management,” says Foulon. “You can't just go in and replace the management team in emerging markets businesses like you can in developed markets. The due diligence process is basically the same as in the West, but it will typically last much longer and you need inside knowledge of local cultures.”

And it's not just management teams of portfolio companies under scrutiny, but those within GP groups as well. “The focus of LPs is on whether GP skill can be transferred from getting capital to work to monitoring the portfolio,” says Laing. “Fundraising is way down, even in emerging markets, and some basic questions are being asked, such as ‘who will survive and who will not?’ It's at times like these that the weaknesses start to show.”

The point made at the outset was that emerging market performance post-crisis can be assessed in two ways: either on its own terms or in comparison with the developed world. Laing's comments serve to highlight a further distinction that can be drawn between the ‘micro’ and the ‘macro’ level. In scrutinising the ‘small picture’, LPs are assessing the impact of the crisis on emerging markets in the short term. In this context, concerns about individual GP groups are entirely valid. The ‘big picture’, with its focus on economic fundamentals, points unerringly in one direction – the continuing rise of emerging markets, and the need for private equity allocation formulae to take this into account.

Over the following pages, you will find detailed analysis of prospects in the many and varied emerging markets around the world.