Emerging markets in bloom

On a recent trip to Washington DC, Graham Winfrey found GPs and LPs hungry to cash in on the rapid growth in emerging economies, but flagged various challenges.

In the world’s most mature private equity market, a lot of attention on the part of investor and manager alike has shifted to emerging markets, where growth is expected to outpace developed nations.

Despite the differences between various economies considered “emerging”, there is still a consensus among GPs and LPs regarding the high level of opportunities that exist in them. World Bank group president Robert Zoellick recently wasted little time affirming this belief.

“Developing countries are now growing about twice as fast as the high income countries and that growth is increasingly based on domestic demand,” he said at the International Finance Corporation’s emerging markets conference in Washington DC last month. “Last year, exports by developing countries grew by about 20 percent and their imports grew even faster, about 22 percent.”

Overheating, Zoellick added, was now the greatest risk in certain emerging economies.

Still, the World Bank estimates the credit gap for micro-, small- and medium-sized enterprises around the world to be over $2 trillion, equivalent to roughly 14 percent of the total GDP of all developing countries.

“There is both a need and opportunity for the involvement of IFC and private equity to help fill this gap,” Zoellick said.
The Carlyle Group is among the fund managers planting flags around the globe in search of interesting such gaps to fill. When looking at opportunities in emerging markets, Carlyle chief investment officer William Conway said he focused more on the specifics of a given transaction than the market in which it takes place.

“We’ve done some wonderful deals in China and we’ve done some terrible deals in China,” he told conference delegates. “We’ve tripled our money in Turkey and we’ve lost all our money in Turkey.” While Conway conceded that emerging markets tended to have an “enormous tail wind of demographics and growth”, he said a common problem lies in getting the management of portfolio companies right.

“In the US, without being too crass about it, if a CEO isn’t working out we shoot him and we go get another one,” Conway said. “In emerging markets you can’t do that. The person you started with is the person you’re usually stuck with until he or she decides that they’re not the person.”

Hamilton Lane chief investment officer Erik Hirsch noted that one common thread between emerging economies was the inefficiencies of markets, which create opportunity for those with the resources and access to generate outsized returns.

“I keep going back to one of the realities of this asset class,” Hirsch said. “We have enormous dispersion of returns. We have it today, we’ve had it for the last 20 years, and that gap frankly isn’t narrowing. I would contend the data is showing that dispersion is getting bigger.”

That dispersion, he warned, was one reason why it’s dangerous to think that all LPs must have an emerging markets private equity portfolio.

“This is a unique asset class where it’s not a level playing field,” he said. “We all don’t get to have the same opportunities and I’m not so sure that the emerging markets are any different.”