EMERGING MARKETS: Parallel thinking

Brazilian public pensions are notoriously demanding of their GPs. Limited partners will always try to get the best deal possible, of course, but Brazil’s pensions go further than most – by insisting on a seat on private equity funds’ investment committees.

This has made international fundraising difficult for Brazilian fund managers. Most LPs are accustomed to their fellow investors taking a relatively passive role on investment decisions. So they’re wary of the potential conflicts of interest that may arise if an institutional investor starts calling the shots.

Fortunately, two Brazilian firms seem to have found a middle ground that can accommodate the needs of all their investors.

Kinea Investimentos, the private equity affiliate of Brazil’s Banco Itaú, closed its Kinea II Private Equity fund on R$1 billion (€377.5 million; $490 million) using parallel vehicles with very different terms, partner Cristiano Lauretti tells Private Equity International.

All the Brazilian institutional investors went into one R$800 million vehicle, while its domestic high net-worth individuals invested in a separate R$200 million vehicle, Lauretti said. If the pensions don’t like an investment, the firm can still complete the deal through the smaller parallel vehicle – which includes terms for co-investment.

“In the smaller vehicle, we have high net worth individuals who invested a small amount,” he said. “But their real [ambition] is to invest in larger vehicles.”

Although Fund II’s LP base is entirely domestic, Lauretti indicated that this structure potentially paves the way for the firm to attract international LPs in the future. But will they find the parallel structure suitable?

“It is a compromise,” says Maureen Downey of Pantheon. “I don’t think it’s a perfect compromise, but it’s a step in the right direction. Will it encourage some investors to come in who are foreign? That remains to be seen.”

Although it bypassed some of the issues that arise from having LPs on the investment committee, the dual-vehicle structure does create other issues. For instance, could the possibility of having two unique portfolios within what is ostensibly the same fund lead to other conflicts?

“If I were a smaller investor, I would want to know that I was coming in the same terms as the larger investors, not only on the way in but on the way out,” Downey says. “If that group declined [a deal], why would it be ok for the other group to go ahead? If it is only appropriate for one group, why is it not appropriate for the other group?”

Another Brazilian firm has chosen to take a different – and arguably less risky – approach. For its latest R$463 million (€174.8 million; $223.5 million) offering, Rio Bravo managed to convince its pension fund LPs to take a seat on the fund’s advisory committee instead (which handles fund governance issues).

“In our model, we were able to put the LPs on the advisory board, not the investment committee. So that way the international investors and the domestics are in the same fund,” managing director Russell Deakin tells Private Equity International.

It’s good news that Brazilian firms are exploring alternative structures. But arguably, it doesn’t solve the underlying problem. “I look at it as a positive,” says Downey. “But do I want to see a wholesale change? Absolutely.”