PEI: How did the emerging markets landscape change during your career?
I think people started seeing the opportunity for emerging markets private equity in the 1990s but it turned out to be uninvestible; the demand was for passive equity. Most GPs were not local, so they didn’t really understand what they were buying into or what to do post-acquisition.
There was a significant change in emerging market funds in the early 2000s. Those vintages have seen 40, 50, 60 percent IRR – backing some of the prime movers, getting good pricing, and catching market growth. Around 2005, returns started to normalise in the first markets to develop. But also the market began to broaden out, and you realised you could start to do country-specific funds in a greater range of countries.
In 1999, it didn’t look like emerging markets had been a great success, but from then to now there has been a great and positive change. The emerging markets part of the private equity industry is really growing in a way that I think is going to be permanent.
How positive are you about the current opportunity?
I think what you’re seeing now is a much more global private equity opportunity set. Emerging markets are more mature and investible; they now account for over 50 percent of global GDP and 12-15 percent of global private equity. All emerging markets now have established GPs that are on Fund 3, so that means they are more mature and accessible. And it is a much deeper market. Emerging markets really should be considered a core part of the private equity portfolio. For investors it’s a question of how you do emerging markets, not if you do emerging markets.
How much notice should investors take of the noise around particular markets?
If you’re just popping around private equity based on macro views, that’s not going to help you in the long run – because you can have really good companies that aren’t impacted by the macro view. The better approach would be to decide to be global starting from the bottom up first, then moving to a top down view. Look at the dry powder, look at the entry prices, then look at the macro issues and see if the micro picture is strong enough to drive through the macro issues.
Investors miss out on opportunities when they rely solely on top-down views that are relative to their home base. It’s an informational symmetry problem. It’s ok to watch small countries, if you pay attention to dry powder and entry prices and how they move. I think one thing IFC always did was look at country funds from the bottom-up, so that gave us a more diversified portfolio. In that sense we were always far off the Cambridge benchmark – but we ended up with top-quartile returns.
What’s the next phase for these markets?
Emerging Markets 3.0 will depend a lot on underlying countries and whether they deregulate and make themselves more business friendly. Modi in India may be a sign that’s happening there, which would be very interesting. These countries also need to improve their legal systems, because the hurdles to due process reduce the deal flow possibilities. It’s really a question of scale. If the BRICS regress, then we shrink the market quite a bit, and that will be troubling. ?