Perspectives 2018 Europe: How to be cool in a crisis

The European Bank for Reconstruction and Development was born in 1991 out of one of the biggest political and economic ruptures of the last century – the collapse of the Soviet Union – amid an undercurrent of volatility.

In the past decade, the bank has had to deal with an array of financial crises and geopolitical ructions such as the conflict between Russia and Ukraine and the Arab Spring, as it goes about its mission: to drive the development of market economies through investment in financial institutions, businesses and infrastructure projects.

Initially focused on the countries of the former Soviet Union, the bank’s remit now spans parts of North Africa, Turkey, Jordan and the West Bank.

Given its emerging markets focus, the bank’s private equity team and its general partners were better prepared than most when the financial crisis struck in 2008. Still, the crisis taught them a lot about the nature of GP-LP relations, the importance of counter-cyclical investing and how hard it can be to keep private money flowing when an emerging market encounters trouble. Anne Fossemalle, the EBRD’s director of equity funds, spoke to PEI, about the challenges it has faced.

Can you remember when you became aware of how serious the crisis was?

In our private equity portfolio it was immediately evident because just before the financial crisis that funds had been investing in a market that was overly optimistic: everyone made assumptions of incredible growth prospects. With the financial crisis it quickly became obvious that this was not going to happen. It had an effect on the entire chain: investors investing in the region, the existing portfolio and a huge impact on the exit pace of funds that were already invested.

You moved to the private equity brief in 2009. What was the top priority in those first few months?

By 2009, it was clear that the fundraising environment had become extremely challenging. There had been a peak in fundraising in the CEE in 2007 due both to growth in the region and because of the natural fundraising cycle. The market isn’t sufficiently deep that you can have many funds raising all the time and in 2006-7 you had Baring Vostok, Mid-Europa and Enterprise all raising funds.

These GPs had jumped in terms of the size of the funds they were managing and suddenly there was a financial crisis. Those investments that they had completed in 2006-7 were much harder to exit and these companies no longer benefitted from the growth prospects of the economy. The role of development financial institutions again became very important.

Before the financial crisis the EBRD was in discussions to gradually scale back activity in certain markets, so we were a smaller investor in some of these funds. Our role is to mobilise private capital, to have a participation in the fund that’s as large as is necessary to act as a catalyst, but small enough not to displace private capital.

The US money withdrew completely, so there was more investment from the DFIs and a much longer time-lag to fundraise. There was a transition phase from when GPs were used to just going like this [she clicks her fingers] for funds and then investing the money. Suddenly, teams had to be more involved in the fundraising and spend a lot more time explaining their track records. The fundraising became much harder and our role became even more critical.

And this would have had repercussions all the way down the chain?

The funds that had been raising money pre-crisis had assets for which they’d paid quite a lot of money and suddenly they weren’t able to sell them for the same multiples. They found themselves having to change their model, becoming even more operational and hands-on than they were before. They had to work on these companies to make sure that the value-add was going to come through. The funds which invested prior to the crisis had much longer holding periods, so there are a whole cluster of funds in our portfolio that have had a much harder time exiting. You don’t just hope the economy will grow and your company will grow with it.

In terms of weathering crises, have you seen GPs invest in a more defensive or counter-cyclical way?

Now they all do that definitely, but those that were more successful were also able to deal with their existing investments.

Some successful GPs are now having quicker fundraises than they had immediately post-crisis partly because they have learned to execute counter-cyclical investments; taking care of the currency aspect and focusing on sectors that are recession proof. Everyone has had to change slightly their strategy and business models.

At the same time, we work in emerging markets that have had their fair share of problems. Our GPs investing money in Turkey and Russia ask themselves questions about potential valuations as a matter of course. They are more used to it than British fund managers were after Brexit with the fall of the currency.

Longer hold periods have led to an increase in the number of proposed GP-led secondaries processes. As an LP, do you ever participate?

We aren’t in a hurry to sell anything – for us the returns are the most important thing. Plus we’re an LP that gives a signal to the market. We have explored selling some funds on the secondaries market but it hasn’t really happened.

How do you feel about the situation today?

In our portfolio the crisis investments are being worked out and exited. That next vintage is actually doing quite well, so hopefully it will continue.

Also, through that financial crisis GPs learned to fundraise better and to take into account their LPs. They don’t take it for granted that the money is going to fly in but understand the importance of listening to what they have to say. They also don’t get too excited by a successful fund. You are only as good as your last fund – indeed after the crisis some GPs left the market altogether.

What keeps you awake at night?

What’s going to be the next geopolitical crisis in the countries where I work. I work in areas like Central Asia, the Caucasus, Mongolia, Greece Turkey and North Africa, which is a younger portfolio for us, so geopolitical matters are at the forefront. I want to see the markets where we work becoming very attractive for LPs again and I can see that even though the returns are good and it’s a good time to invest, because of geopolitical issues investors aren’t going to be flying in.

You have market situations that you can still exploit. There is a lack of health services and education services. In Poland, industry entrepreneurs who created their companies 25 years ago are now ready to exit. There are great opportunities for PE to invest. An investment officer looking at making an investment in Turkey might be really keen on a deal, but their colleagues on an investment committee headquartered in the US less so. There’s always that gut reaction when you are sitting on an investment committee. Is this an environment that’s conducive to successful investments?