In praise of volatility

“The way it looks today is not as it looked a few years ago,” says Hamilton Lane managing director Juan Delgado-Moreira, summing up the investment picture in emerging markets.

Back then, investors tended to look at private equity in emerging markets as a GDP growth play. Large economies were expanding at double-digit rates, even as developed countries struggled.

Those days are over. The heart of the emerging markets – China, India and Brazil – is beating slower, and realisations have become increasingly tough. China, the most significant of the emerging markets, is expected to average 6-7 percent annual GDP growth in the next few years, rather than the 9-10 percent average of previous years. India’s GDP growth plunged from 10.5 percent in 2010 to 3.2 percent last year, according to the World Bank, while during the same period, Brazil’s plummeted from 7.5 percent to 0.9 percent.

Particularly in China and India, some GPs are holding onto investments (and collecting fees), waiting for better times to exit via the public markets.

More uncertainty comes from the eventual end of the US Federal Reserve’s quantitative easing policy, which promises to spark capital flight from emerging markets as interest rates rise. The mere expectation of QE tapering earlier this year sent currencies plunging in India and Indonesia (amongst others).

All told, these macro issues give investors in developing markets reason to pause.

Indeed, the situation now arguably looks better in the US, where economic growth is inching upward, the public markets are outperforming, and exits and fundraising are climbing.“Some investors are thinking it’s time to reallocate from emerging markets to the US,” Delgado-Moreira says.


In China, exits and liquidity have been problematic, and returns have weakened, sources agree. Domestic IPOs have been frozen for more than a year, with no set date for the market to reopen as regulators reform the listing process. Because most deals in Asia involve minority stakes, divestments through trade sales are difficult, forcing fund managers to hold onto assets as they search for ways to sell out.

“China has been such a massive driver of the fundraising for emerging markets, but has produced very little in the way of positive returns in the last two years,” says Javad Movsoumov, executive director at UBS private funds group in Singapore. “Common questions for a China fund manager are: ‘What are your exit scenarios other than IPO?’ ‘Is there a redemption clause to get capital out?’”

Mark Machin, president of the Canada Pension Plan Investment Board in Asia, echoes that sentiment: “Emerging market returns relative to the developed markets have not been as strong over the last few years, particularly for China.”

Mark-to-market is a big issue, adds Delgado-Moreira. “The combination of lower values in listed equity markets and mark-to-market of assets held by private equity has resulted in negative performance.”

Investor disappointment is also focused on India, which has its own liquidity problem in addition to regulatory uncertainty and other macroeconomic headwinds. Many current investments were made in the boom time of 2007-2008; today, the plunging rupee and weak public markets have made the climate for divestments unappealing. Again, many GPs are holding and waiting. A large proportion – maybe as much as half – of all private equity funds in the country are thought to be zombie funds.

That’s not sitting well with LPs: only $1.67 billion was raised for India in 2012, compared to $4.2 billion the year before, according to Private Equity International’s Research & Analytics division.Brazil is another floundering giant. The enthusiasm for the country that was evident three years ago has waned, largely due to the steep plunge in GDP growth. In the weakened economy, GPs have to find deals where they can add meaningful value and increase EBITDA, not just ride a wave. This year to November, Brazil has attracted the lowest level of private equity investment ex-real estate ($449 million) since 2009, according to Mergermarket data.