Emerging markets: Where others fear to tread

Emerging markets will generate 60 percent of global gross domestic product by 2020, according to EMPEA. This might imply investors would, or should, be allocating 60 percent of their investment capital to the space, which they are clearly not. Developing countries attract only 15 percent to 20 percent of the private equity wallet, despite both higher relative growth rates and higher total economic activity.

There are many reasons investors are staying in established markets rather than looking for profits elsewhere. Their concerns include currency risk, political volatility, deal access and historic returns. On top of actual risks are even more perceived risks, and many investors are not yet convinced that the returns justify the potential drawbacks.

The Overseas Private Investment Corporation is familiar with many of these risks and has a long track record of navigating them. Since 1991, OPIC’s investment funds department has invested $5.6 billion across 82 funds operating in emerging markets around the world.

Our development mission is to mobilise private capital in emerging markets, and we have done this in many ways. Funds we have supported have built affordable housing developments, food processing plants, telecom tower networks, schools, hospitals, consumer goods businesses and tourist destinations, and created local jobs that help promote economic stability and growth.

One of the keys to encouraging investment is our ability to address the risk – real and perceived – of working in emerging markets.

Many investors, including the vast majority of pensions in North America and Europe, lack the resources to do due diligence on faraway managers who may or may not achieve a target fund size. We are happy to go first. Alongside a qualified gatekeeper, OPIC will devote the resources to interview the team, visit the portfolio companies, research the target sectors and examine the fund terms, among other diligence items. In the process, we help new and emerging managers bring their data room closer to an institutional standard. OPIC’s commitment to a fund signals to major investors that the manager is approaching a first close and the data room is up to scratch.

Learning who you are dealing with in the US or Europe is relatively straightforward because networks overlap, common languages are spoken and information can be found online. None of this applies in frontier markets. OPIC’s access to US government databases to check on the integrity of stakeholders puts it in a unique position. Before we present a transaction for board approval, for example, we contact the local embassy to ask whether there is any information that should give us pause. This provides an extra layer of integrity diligence that can be reassuring.

While emerging markets offer significant potential, they often struggle against corruption, inefficiency or lack of consistent business practices, which can all contribute to a challenging business environment. There are several public assessments that attempt to quantify the level of transparency and the business environment in different countries that help to guide investors. If an unexpected issue with a government institution comes up during a holding period for an investment, OPIC is able to engage on these issues directly through the State Department’s network of embassies.

For example, on behalf of current fund managers, OPIC has engaged with embassies to call on a central bank to expedite a foreign currency disbursement, call a regulator to get fairer treatment for a broadcast license, participated in court proceedings to address a corruption issue, visited a mayor to enforce a contractual payment obligation and written a letter expressing concerns about dividend streams – all with positive outcomes.

Regulatory agencies of North America and Europe provide a baseline level of accountability and compliance for any company operating in their jurisdictions. In emerging markets, these bodies may not necessarily be implementing the same standards for best practice, or they may lack the resources to enforce compliance, which can increase risk. OPIC can address this in two ways. Before investing we make sure the fund manager is not only going to apply local law, but also that they are going to apply the International Finance Corporation’s standards for human rights, environment, labour and other core factors. We also conduct on-site monitoring of active projects.

A growing number of private equity investors are seeking to achieve greater environmental, social and economic impact through their work, and some will not commit to an investment without knowing the projected impact. ESG reporting is a requirement for all our fund managers, and we maintain a dedicated team of analysts and economists to study this data. These resources enable us to ensure that the fund’s reporting meets a high standard.

Because investing in emerging markets poses its own sets of challenges, OPIC offers insurance to protect investors against several of the common political risks they face. OPIC can write policies that will underwrite managers against currency inconvertibility, political violence, expropriation and sovereign non-honouring of contractual obligations. We can help a buyer at acquisition or a potential buyer of an asset at realisation.

Emerging markets are more complicated and more challenging than developed markets in many ways. But given their contribution to our collective GDP, these markets are worth a closer look. By helping investors feel more comfortable, OPIC is helping them engage in some high-growth places with significant potential to achieve returns and make a positive difference on the ground.