An LP-free zone?

Sri Lanka’s golden sandy beaches may be fewer than 50 kilometres from India, but the gulf between the two countries’ respective private equity markets remains vast.

Two years after the end of a 30-year civil war, Sri Lanka is expected to have real GDP growth of 6.5 percent in 2012 and a more stable economic environment for its 20.8 million population, according to the IMF. Its proximity and commercial connections to India also position the economy well for growth.

Yet LPs remain wary. Sev Vettivetpillai, chief executive of emerging markets specialist Aureos Capital and also a native Sri Lankan, said: “Post-war, the Sri Lankan market has suffered considerably in terms of lack of investment. The traditional investors in Sri Lanka like [UK development finance institution] CDC and [Dutch development bank] FMO have decided not to invest in the near future because they aren’t happy with the governance and human rights issues.”

Volatility is also a problem, says Vettivetpillai. In March, Sri Lanka’s currency depreciated by 18 percent against the US dollar. “That kind of depreciation in one go impacts returns. We’ve been saying the [Sri Lankan] rupee has been overvalued for two years and the government kept it at that level for obvious reasons. These kinds of decisions are the ones that keep private equity investors like us away from the market.”

Sources say global players like The Blackstone Group and Warburg Pincus have been scoping out the landscape, but haven’t yet done any deals.

A number of smaller firms have in recent years been trying to raise Sri Lanka-focused funds, but they haven’t had much luck. In 2009, Leopard Capital made an unsuccessful attempt to raise a Sri Lanka-focused vehicle. “We were unable to uncover sufficient investor interest at the time and suspended the project,” explains Douglas Clayton, founder of Leopard. But he still believes in Sri Lanka’s opportunities, he says.

Singapore-based Calamander Group also launched a fund in 2009 after the long war ended; hopes were high, but again, it could not attract enough investor interest. Calamander now invests in Sri Lanka on a deal-by-deal basis, says director Mafaz Ishak. He believes tourism is a key sector; the firm has invested in Unawatuna Beach Resort while the beaches there recover from the devastating tsunami of 2004.

One native GP is now giving fundraising another try. Indika Hettiarachchi was Aureos’ managing partner for Sri Lanka before moving on to launch a $50 million fund for the country. He insists opportunities are rife. “Based on my actual experience and assessment of the market trends, it is possible to target minimum 23 percent IRR in US dollar terms.” Hettiarachchi is currently trying to secure a local anchor investor.

In addition, investment firm LR Global recently secured a $10 million investment in its Sri Lankan-focused fund (equivalent to 20 percent of the target) from the International Finance Corporation – proving that there is some LP interest in the country.

Perhaps the answer is a strategy that does not rely solely on Sri Lanka. Aureos’ Vettivetpillai admits, “I would not invest in Sri Lanka alone. I would put my capital across three markets – India, Sri Lanka and Bangladesh. Sri Lanka alone would be too risky.”