Emerging market economies have had a rough ride in the last 18 months as fears of a Chinese slowdown, commodity price volatility and concerns over US interest rate rises spooked investors in public equity and bond markets.
Yet, in private debt, the story has been different. Just as Europe and Asia’s more developed economies have seen private debt grow as a funding source for companies and an asset class for investors, so now are a number of emerging and frontier markets.
Private equity funds like Gulf Capital are diversifying into the space, as is Linzor Capital Partners, which recently acquired GE Capital’s Mexican equipment and leasing business, including a portfolio of over $1.1 billion of assets.
Specialist funds, particularly those with an impact investing flavour, are also emerging: responsAbility Investments recently announced a $30 million first close on an Africa- and Asia-focused clean energy fund, with The Shell Foundation and the IFC as anchor investors. And partnerships are being formed to allow established funds to access ‘harder to reach’ opportunities, such as TriLinc’s recent agreement with Mexico’s Alsis and Gulf Capital’s partnership with Serengeti to target sub-Saharan Africa.
At the same time, appetite for private debt funds that target emerging markets is growing – the $6.2 billion raised last year was more than a sixfold increase on 2008, according to PDI Research & Analytics. And, while global fundraising totals are down for private debt funds in 2016 so far, early indications are that this will be another strong year for emerging markets, with $1.6 billion raised by the time PDI went to press.
Funds in China and other more developed Asia-Pacific countries account for a large share, yet less well-trodden markets are also witnessing growth. In Vietnam, the International Finance Group committed $50 million to the country’s Dragon Capital Group to invest in medium- and large-sized Vietnamese companies.
Latin America saw three fund closes. The largest was a $451 million Colombian infrastructure debt fund raised by Ashmore Group in conjunction with Corporación Andina de Fomento, the development bank. And, with local pension reforms in some Latin American countries on the way, the private debt fund market may be set for further growth in the region.
“Pension funds here, particularly in Peru, are undergoing regulatory changes,” says Carlos Anderson, Latin American advisor at Gramercy, the pan-emerging markets investment advisor. “These will mean that they can invest with more flexibility and in more diverse instruments, including more in alternatives.”
PRIVATE DEBT 2.0
Much of the lead is being taken by development finance institutions (DFIs) and local investors, yet there are signs that international private investors are starting to take notice. This is being helped by initiatives like that launched last year by the IFC to offer managed accounts to investors for infrastructure debt in a bid to mobilise more private capital into the sector.
“We are starting to see version 2.0 of private debt funding,” says Jim Sosnicky, vice-president of origination at Cordiant Capital, which reached a $350 million close on its fourth emerging loan fund last year. “As with private equity, the DFIs have been early supporters, who have provided proof of concept and shown that companies in emerging markets are investable. Now, as funds have built up a track record, private LPs are starting to take more notice.”
He adds: “We recently closed a substantial managed account for B loans with a very large European investor. In addition, we are seeing a lot of opportunity in agribusiness trade finance, something we’ve been doing for 15 years as part of multi-strategy funds and we are now breaking out as a separate strategy in a new, dedicated fund. LPs are showing a high degree of interest.”
It’s a trend also noted by Walid Cherif, managing director of Gulf Capital Credit Partners. The firm is currently in the market to raise $250 million for its second private debt fund, targeting the Middle East and North Africa as well as sub-Saharan Africa following its tie-up with Serengeti Capital.
“We reached our first close at the end of last year with $175 million and have some DFI money and backing from local investors,” he says. “But we’re hoping to attract some European and Asian institutions, too. International private investor appetite for emerging markets private debt is starting from a low base, but it is definitely attracting more interest.”
Many LPs interested in emerging markets have already dipped their toe in the water with commitments to private equity funds, although results have often been mixed particularly in regions where exits have been difficult to achieve.
“Private debt provides a different risk profile from private equity and has advantages that resonate with certain investors,” says Samson Ampofo, vice-president at Cordiant. “Exits are better defined, compared to private equity where public exits can be challenging due to lower trade sale volumes. In addition, with private debt there is a greater ability to structure creatively to mitigate risk.”
So what of the opportunity on the ground in emerging markets? As with more developed economies, poor availability of traditional bank lending in the wake of regulatory reform is one of the key drivers for the growth of private debt, Sosnicky says.
“When you look at emerging markets and remove China and the extractive industries, you are looking at a very different animal – both at an industry and macro level,” he says. “There is a robust universe of high quality companies with good track records and solid assets that have historically relied on bank financing, but that now face a debt funding vacuum as the banks have pulled back in response to Basel III. Many prefer not to opt for equity finance as that can entail a loss of control and so they are increasingly turning to private debt funds.”
For Cordiant, that translates into a number of different opportunities in frontier markets. “We have a preference for the frontier markets because we can see clear, unaddressed market demands,” says Ampofo. “For instance, in infrastructure, many countries need better power generation, particularly in areas where power is rationed and distribution capabilities need to keep up with demand; roads; agriculture (processing facilities and warehouses); and new or upgraded ports. We also look at markets where growth is driven by strong local demand.”
And while funds generally say they look to the longer term, the more volatile economic picture witnessed by many emerging and frontier markets is creating favourable conditions.
“The current situation is providing us with some good opportunities,” says Cherif. “Commodity-based economies are suffering from low prices and a shortage of US dollars and this is on top of a banking system with low liquidity. We are seeing a lot of fundamentally sound companies that lack sources of financing. At the same time, the longer-term fundamentals of the markets in which they operate are strong … These opportunities can offer higher returns on a risk-adjusted basis than more developed economies.”
It’s a view shared by Ampofo, who expects some stabilisation over the coming 12-24 months in many emerging markets.
Perhaps also one where growth may well trend higher than some expect.
“As a result of significant depreciation of many emerging markets currencies,” he says, “there is an opportunity for increased trade and exports, which could drive domestic economic activity higher.”