The zeal of the newly converted LP

The rise of domestic limited partners in emerging economies is without a doubt a good development for the industry. Not only does it promise further growth for the private equity asset class around the world, but the participation of locals brings further legitimacy to burgeoning markets that are sometimes viewed with suspicion by regulators.

That said, the entrance of new LPs into the asset class may create some problematic side effects, such as the proliferation of sub-par, first-time fund managers who could lose money and impair whatever goodwill was necessary to attract new entrants in the first place.

The rise of domestic LPs was a key discussion point at the recently concluded Global Private Equity Conference in Washington DC, an event sponsored by the International Finance Corporation and the Emerging Markets Private Equity Association that drew some 800 people from around the world.

Christopher Witkowsky

One panellist, Jennifer Brooy, vice president and head of equity at Export Development Canada, noted a similar development in her home market years earlier. “It’s certainly concerning,” she said. “In Canada, on the venture capital side of things, we had a huge inflow of capital that was not necessarily smart capital, and the results were a whole pile of funds created and a lot of people lost a lot of money,”

Brooy added: “As a consequence, we saw some institutional investors pulling away from the asset class completely. If we repeat that behavior, we’ll see that same kind of evolutionary cycle.”

Panellists noted that LPs in emerging markets in many cases are allowed entry into alternative investments due to changes in regulations, and some because of interest on the part of their institutions to diversify and boost weak portfolio performances.

But this new money, while celebrated by many as good news in an otherwise beleaguered fundraising market, will need to be kept disciplined. New LPs must not agree to commit to every manager that comes through the door. They must carefully study the mistakes made by experienced LPs.

Panellists voiced concern about increased competition among emerging-market LPs to get into funds. “There’s a dynamic where there’s only so many funds, there’s access constraints, and that changes the dynamic,” Maninder Saluja, co-head of emerging markets private equity at Quilvest Group, said.

Another concern is that a flood capital from new investors could dilute the impact that many hope the Institutional Limited Partner Association standards have on the industry, panelists said. So far, emerging markets LPs haven’t been pushing hard on the ILPA-suggested principles for terms and conditions, especially those LPs that are just entering the asset class.

“In the emerging markets, there are more first-time [LPs], a lot of people anxious to get funds going, so they are more flexible on all fee terms, on all principles,” according to Saluja.

By contrast, in the rest of the world, LPs have gained more leverage in their relationship with GPs. Because of the stale fundraising environment of the past year, GPs have been “more conciliatory” to changing terms in favor of LP groups, Saluja said.

To be sure, Brooy was quick to note, the dynamic in the industry that seems to favour LPs these days is more of a “movement in the right direction” rather than a “shift”.

The most important improvement in the rise of the ILPA has been greater communication among investors. As new pockets of capital for private equity open up around the world, the people that manage these should carefully consult with seasoned LPs and check their natural enthusiasm to put capital to work with the first managers to offer the excitement of private equity deals.