Private Equity with a New Attitude: As recently as 2009, bringing up frontier market investing would have left you finishing your drink alone at the conference bar as well as producing mixed results on your portfolio. With a 66% decline from the US$67 billion raised in 2008, fundraising in developing markets appeared to plummet right along with the global decline with a 55% fall in value for emerging market focused transaction volumes during the recent economic crisis . However, there was a surprising recovery the following year which was particularly marked in Latin America with a >500% increase by investment value to US$6.65bn, and in emerging Asia with more than 60% of the US$18.3bn that was raised in emerging markets during that period. What was going on?
PE and Tomorrow’s Global Growth Generators
By 2011 many investors were publicly calling for increased allocations to the emerging markets that were left behind by the BRIC (Brazil, Russia, India & China) euphoria. Jim O’Neill of Goldman Sachs who coined the BRIC acronym in 2001, recently hinted that the four goliaths of the emerging markets may have had their day. The December 2011 report states that, "In terms of the role of the BRICs in driving global growth, the most dramatic change is behind us." . The same report continues: “…it is much harder to accept that simply believing in their long-term growth dynamics can be a sufficient investment thesis now, if it ever was.”
O’Neill recently told Bloomberg that other emerging economies may now be better investments -- especially Indonesia, Turkey, Egypt and Mexico. “These four countries could be in the top 10 contributors to global GDP this decade, adding well over $2 trillion. With large young populations, these countries could become powerful growth stories.” Deutsche Bank recently published predictions that identified eight sub-Saharan Africa countries that have averaged the same growth rate delivered previously by the BRIC economies.
These ‘other emerging’ economies – often referred to as frontier markets – are a subset within the broader field of Emerging Markets with lower market capitalisations and liquidity than the more developed emerging markets. While no definitive list exists, Frontier Markets comprise up to 40 countries spread across Asia, the Middle East, Africa, South America and Eastern Europe. The most commonly mentioned in Asia are Indonesia, Vietnam and Kazakhstan; in Africa, Nigeria and South Africa; in the Middle East, Egypt and Qatar; in South America, Peru, Columbia and Chile; and in Europe, Ukraine and Romania. These markets currently make up roughly 4% of global GDP and, generally speaking, are those that are at the early stages of industrialization and have the potential to achieve above average growth over the next 5 to 15 years.
The High Interest in Low-Income Countries
2.5 billion people in the world live on less than $2.50 per day and in Sub-Saharan Africa and South Asia, 50.9% and 40.3% live on less than $1.25 a day, respectively . Those earning above the $2 per day level tend to be able to save money, to be upwardly mobile and capable of driving a consumer-led economy. Southeast Asia alone is on track to have added 250 million middle class consumers between 2004 and 2014. These regions’ industrialization and infrastructure, including their ability to raise external financing, will be key to developing consumer spending capacity for these massively needy populations and swelling demand for consumer goods and services. J.P. Morgan estimates somewhere between a half and $1bn could be invested in these regions over the next ten years to fund the capital needs of just five sub-sectors: urban housing, clean water for rural communities, maternal health, primary education and microfinance. The Human Development Index states that developing nations today account for >80% of the world’s population whilst having only 7% of world equity market capitalization. With the well-known intrinsic complications of aid programs, notably inefficiencies, politicizing and frequent corruption, private equity becomes less of an option and more of a necessity for the future of low income markets.
What are the returns?
Any discussion of such a varied range of countries can only offer a broad overview. Needless to say, there are huge opportunities to be uncovered, and strong returns to be made. A recent poll conducted by EMPEA with Coller Capital found that 54% of LPs expect to achieve +16% annual returns on their emerging market PE investments while only 33% have similar expectations from their global PE portfolio . Another recent study found the expected returns of many existing impact investments in emerging markets fall largely in the 8-11.9 percent bracket for debt investments, and into the 20-24.9% bracket for equity .
Obviously, the opportunity and risk of any specific investment will vary greatly. The point here is that frontier market investment returns are intrinsically less correlated to global market movements as these economies are immature and address the fundamental needs of large growing populations with enormous unmet needs. Knowledgeable and disciplined managers can and do generate healthy returns while affording their portfolio diversification from highly interdependent global markets.
But This Isn’t Just About Money
There’s a 2nd ROI at play: As a PE investor ‘getting in at the ground floor’, your allocated funds may well have a bigger impact than you imagine: on both regional economic development and social justice in the lives of local inhabitants. All of a sudden, this isn’t just another day at the office as a fund manager. Your work now goes further than the confines of pure financial returns. Think: a catalyst for social change.
Beyond the Numbers
PE investments create value in portfolio companies by improving corporate governance, introducing controls and reporting, rationalizing cost-structures etc. This value-added often transforms the communities in which these companies operate; positively impacting sustainability and people’s lives through improved services, local labor practices and proactive engagement with local stakeholders. There are many compelling examples that demonstrate private equity’s ability to provide the catalyst for positive social change. Here are but a few touchstones:
Challenges and Barriers
While the rewards can be higher, myriad challenges can impact financial returns:
Bottom Line: Investment Managers with a New Attitude
The recent global financial crisis and social unrest throughout the Middle East demonstrate the need for a new investing attitude. PE investors in emerging markets are the new generation of impact players both socially and economically and the change starts from within. Views of investment activities shouldn’t be constrained to a financial ROI, but from within the context of providing a critical channel of financing for economic development that makes companies more competitive and effects real and positive change in people’s lives and the communities of these investments. There needn’t be a tradeoff between financial performance and environmental, social and governance concerns; The new generation private equity investment manager delivers significant social benefit as well as superior financial returns.