Emerging markets: niche value

In August, profit-with purpose firm LeapFrog Investments closed its second fund on its target and hard-cap of $400 million. Ten days later, New York-based healthcare specialist OrbiMed Advisors closed its second Asia-focused fund on $325 million, above its original $300 million target.

According to partners at both firms, as well as the obvious attraction of tapping into growth markets, LPs were drawn to the sector-specific nature of the offerings.

LeapFrog says that it ended up having to turn investors away, despite only realising one deal so far from its debut $135 million vehicle – the sale of Ghanaian life insurer Express Life to Prudential in 2013, which generated an internal rate of return of 82 percent.

According to co-founder and partner Jim Roth, LPs were attracted to LeapFrog’s team, which includes both investment professionals and insurance industry specialists. “Your scope and prospects for creating value are just aided if you know the business really, really well,” Roth said. “You really have to know the countries inside out. I think that’s one of the things that LPs responded to in the fundraise.”

In fact, Leapfrog is pretty much the only private equity firm that specialises in emerging markets insurance. This can be an advantage in deal execution, he says. “Even if there was an auction process, that would be shut down and it would become a bilateral, just because we could talk insurance to [CEOs] in very specific ways. It was clear that we could add value very technically.”

This helps to explain why LPs value sector specialism: because it mitigates some of the execution risks often inherent in emerging markets. The firm’s ‘profit with purpose’ strategy is also an important component of this, he adds, because it reduces partner risk.

Specialism can also be valuable in helping to attract engaged LPs with a vested interest. LeapFrog counts several of the world’s largest insurers and re-insurers, including AIG, MetLife, Prudential, AXA and Zurich, amongst its investors.

“They’re interested in learning more about those markets,” Roth said. “They also want to co-invest in those markets because it’s in their field. And they will be potential partners to buy the assets on exit.”

OrbiMed also benefited from its specialist credentials when raising Asia Partners II, according to partner Carter Neild. As “the only pan-Asia healthcare private equity group”, the firm could easily distinguish itself from more generalist competitors.

Specialist doesn’t have to mean sub-scale, as OrbiMed proves: with around $11 billion of net assets under management, it considers itself the world’s largest healthcare-dedicated investment firm. This creates opportunities for synergies across its portfolio, Neild says. “We’re seeing Asian companies trying to access Western products, [and] Western companies trying to access the consumer in Asia.”

LPs do tend to like sector specialisation, especially in highly technical industries such as healthcare and financial services, says Francesco di Valmarana, partner at Pantheon Ventures. “Domain expertise or sector specialisation always gives you an edge over your competitors,” he explains – although he adds the caveat that being too focused could limit deal flow.

Enrique Cuan, managing partner at Mercury Capital Advisors, says that although it’s intuitive to think generalist managers are better positioned to take advantage of immature markets, sometimes esoteric funds – such as the $265 million fund dedicated to building car parks in China that Mercury helped raise – can resonate.

“You would think that those types of niche strategies are harder to raise, but interestingly they often pique the curiosity of investors,” Cuan said. “You have to make an educated guess on what the market is willing to accept.”

For LeapFrog and OrbiMed, the market has clearly been very accepting.