When allocating assets geographically to private equity, it is tempting to use aggregates. Countries are often blended in categories such as ‘North America’, ‘Western Europe’, ‘Eastern Europe’ or ‘Latin America’. These convenient shortcuts have their advantages, but they can also have significant negative consequences.

Thibaut de Laval

For example, a macroeconomic or political event affecting one country can easily be perceived as spilling over to an entire region, even though it might not have those effects in reality. This perceived contagion could ultimately lead investors to dismiss an entire region, damaging their return prospects and their risk diversification.

Turkey could easily be one such country that is difficult to categorise, standing as it does at the crossroads between Europe, the Caucasus and the Middle East. Investors could carve out a specific allocation for this country, but this would in effect require them to invest regardless of its ability to accommodate the inflow of capital. Therefore, it could make sense to integrate it to one of the regions listed above. But which one?

According to data from eFront, the pooled average performance of Turkish private equity and venture capital funds to date sits at 12.6 percent on an internal rate of return basis and 1.61x in terms of total value to paid-in. The top 5 percent of funds, meanwhile, achieve an average IRR of 18.6 percent and a TVPI of 2.03x, while the top-quartile performance actually sits below the pooled average performance. This suggests that the best performers include larger funds.

In comparison to other regions, Turkish funds appear to do rather well, sitting close to their peers in developed markets – and actually outperforming them slightly. Since inception to the end of 2017, Turkish private equity funds’ return of 1.61x sits above that seen for Western Europe (1.46x), and the US (1.5x) and well above the 1.25x seen in south-east Europe. Turkish funds are also, at present, less risky, with lower selection risk than seen elsewhere (as measured by the performance differential between best and worst performers).

This highly positive performance, however, does need to be treated with some caution. While paid-in committed capital in Turkey is high, at 0.82x, compared with 0.93x for Western Europe and 0.87x for the US, maturity (or returned capital) is lower. Western European and US funds have returned 53.4 percent and 51.3 percent of paid-in capital respectively, compared with just 36.6 percent for Turkish funds.

Much of the performance of Turkey’s funds is therefore yet to be realised. As is usual with less mature markets, the dispersion of performance is more limited and therefore the figures for selection risk could well rise as the market matures.

Nevertheless, it is encouraging for Turkish private equity that performance sits at such a positive level. In the light of the Turkish debt crisis in 2018 and with the lira deprecating by 40 percent since the beginning of the year, these figures put the country’s private equity community in a strong position before any effects of an economic downturn are reflected in private equity returns.

It is also worth noting that more than half of the capital deployed to date has been invested in export-oriented business with income in foreign currency, which makes the market partially immune to the currency crisis. Assuming that their performance can be continued, Turkish private equity funds appear potentially very attractive for fund investors, with high performance and relatively limited risk.

The logical conclusion is that if Turkish private equity funds are not an investment category on their own due to capacity constraints, they could be included in an alternative, developed market bucket such as Western Europe. This would enlarge the investment universe of fund investors and add the region is a possible source of risk diversification while providing attractive returns.

– Thibaut de Laval is chief strategy officer at private equity software provider eFront