We are in a period of 'extreme uncertainty' – IFC

Principal investment advisor at the International Finance Corporation Ralph Keitel says that with China’s two decades of high growth almost over, GPs and LPs have to adjust expectations to a ‘new normal’ low growth environment.

For almost forty years, the International Finance Corporation (IFC), the World Bank's investment arm, has been an active investor in private equity, investing about $500 million annually into funds focused on developing countries.

In the East Asia Pacific region alone, its long-term investments totalled $3.3 billion in fiscal year 2015, including $1.1 billion from other investors.

Managers the IFC has committed to include Kotak Mahindra Group's Kotak India Private Equity Fund III, Olympus Capital Holdings' Asia Environmental Partners II, Brummer & Partners' Frontier Bangladesh II and Philippines-focused Navegar Fund, and Everstone Capital's Everstone Capital Partners III, among others, according to PEI Research & Analytics.

Ralph Keitel, principal investment officer at the IFC, tells Private Equity International about the organisation's approach to investing.

Q: What markets catch your eye?
A: The IFC has been very supportive of southeast Asia, with more than half of our program in the east Asia Pacific directed at the region.

Two countries that are poised for strong growth in the coming years and thus currently favoured by the investment community are Vietnam and the Philippines – despite elections coming up this year in the Philippines.

Another country currently flying high in investor sentiment is Myanmar which held successful democratic elections late last year. Early indications suggest that laws and regulations are expected to be implemented which aim to encourage foreign investment but, obviously, one has to see how this process unfolds in practice.

Q: What is creating volatility in emerging markets?
A: Right now we seem to be in a period of extreme uncertainty. When the Fed finally raised its rates, people had long built this into their expectations and things seemed to be on a clearer path. But now, with the economy in the US stuttering and the EU mired in political tensions, volatility has gone up again. I would think that both these issues will be resolved in the next 12 to 24 months and make way for a more stable outlook.

But what is unlikely to come back are the very benign conditions of the past. Growth in China is decelerating and US interest rates are poised to rise eventually so these locomotives of global growth will no longer be in place to help lift all the boats. As a consequence, developing countries need to make efforts to implement business reforms that encourage private sector development and avoid running large deficits which can lead to inflation, currency depreciation and, ultimately, capital flight.

Q: Is there any good news?
A: The good news is that two decades of strong growth have helped to create a middle class in many developing countries, with increasing disposable incomes available for discretionary spending. These are the new engine driving economic growth – but that engine is not running as fast as before without the help of the twin turbochargers [of record low interest rates and high Chinese growth and demand for commodities] of the past.

Overall, the emerging market 'story' remains intact but, with global growth slowing down, growth rates in emerging markets have also come down below the abnormally high rates we've seen in the past. So all participants – entrepreneurs, GPs and LPs – have to adjust their expectations downwards in this 'new normal' environment of lower growth.”

Q: How are private equity managers received in emerging markets?
A: What you now have in many countries is what I would call “lighthouse deals”, i.e. some very successful transactions where entrepreneurs have seen the positive wealth effect that private equity and venture capital can bring, so I think there is a much wider understanding of the asset class.

Another factor that will continue to benefit private equity in emerging markets, particularly in frontier markets, is that globally banks have taken a significant hit and are trading at record-low valuations. What this means is that banks are very reluctant to expand their balance sheet – or are shrinking them – so fast-growing small and medium enterprises have nowhere to turn but to private equity to finance their growth.”

Q: How does the IFC select markets to deploy capital?
A: When we look at our target countries, we do so from different angles: how much quality deal flow is there and what's driving it; what's the competitive environment – both institutional private equity and non-institutional sources of capital. One other thing we look at very closely is the local environment (e.g., political, legal, regulatory) and how conducive it is to the private sector's business activities. We like countries that are implementing reforms which benefit the private sector, for example putting an open trade environment at the centre of their government policy.

Q: What's the key to private equity success in frontier markets?
A: Nothing beats long-term experience of a limited partner and being able to apply past experience in new markets. A long-term investment horizon is key when investing in emerging markets private equity.

If you're an investor in any asset class and you don't know what's happening on the ground, then you have a very limited ability to question or challenge the GP. You then either accept at face value what the GP tells you or if you don't feel comfortable doing that then you are probably better off avoiding the risk and not investing.