As more money enters private equity, it puts greater pressure on managers to identify deals, even if it means paying a premium well above a prospect’s EBITDA. Some managers are simply holding off making investments, as evidenced by the reduction in deal numbers over the course of 2017. While private equity capital raising has been successful, limited partner (LP) tolerance will be tested if their money is not deployed in a timely fashion. Many LP’s are asking whether private equity realtors are sustainable in the long-term given asset valuations.
Private equity managers understand that well priced deals are not in abundance. The need for alpha and the desire to acquire assets at sensible valuations is leading some private equity firms to look at emerging markets more closely. Historically, private equity portfolios have been very North American and European centric, but this is changing as managers spot promising growth areas in emerging economies.
Assets under management (AUM) at emerging market-focused private equity firms have been rising over the last eight years. In 2010, these managers comprised $254 billion although this has since mushroomed to $564 billion as of September 2016. Since December 2006, this represents an annual average growth rate in AUM of 21%.
Getting emerging market investments right
A cautious approach towards emerging markets has been borne out of several factors. Firstly, a number of private equity managers have looked at emerging market risk with some concern while others have a home bias, namely they are more comfortable investing in more familiar local markets. In addition, only 14% of private equity investors are based in emerging markets. Attitudes are, however, shifting with managers becoming more willing to test the waters in some emerging or frontier market companies as the understanding risk/risk management techniques evolves. The graded increase in availability of quality local resources and partners has also helped.
Despite the fact that some of these economies lack liquidity, assets are reasonably priced and limited foreign investment creates excellent return opportunities. Emerging markets offer an effective diversification tool. Some firms are also reluctant to allocate more capital to developed markets due to political instability in the US, and the unknown consequences of Brexit. By investing in emerging markets, firms can accrue new sources of returns.
The proliferation of emerging market investing will also likely result in expanding the secondary market. LPs often view secondary markets as a useful resource for unloading underperforming assets or lock in returns at decent prices. One expert – speaking at the International SuperReturn conference – acknowledged that there has been a noticeable uptick in secondary deal flow emanating from Africa.
On the macro-side, emerging economies are not saddled with ageing populations but are replete with young people of working age, which is conducive to growth and development. The expansion of the middle class across Asia and Africa has been spectacular, and this is leading to a surge in consumer spending.
Simultaneously, technological innovation across many of these markets has overtaken the progress being made in the developed world, mainly because there is little or no legacy infrastructure, allowing these countries to introduce change from scratch as opposed to having to integrate it into existing systems. Again, this creates investment opportunities for GPs.
Emerging market investing does of course carry risks. The absence of a tried and tested regulatory regime, an efficient enabling legislation, political risk, weak corporate governance and insufficient investor protections in some countries pose a problem. For managers, it is essential they work with qualified, and legitimate, local providers when sourcing deals in emerging economies.
A handful of emerging markets have implemented capital controls and restrictions around repatriating currency as a means to control economic volatility. Recent examples include China and Egypt. This presents an unquantifiable risk to managers and their investments. It is crucial for firms to monitor monetary policy and political developments in the markets they invest in on a regular basis.
Emerging Markets: The Future
The case for emerging market investing is strong. Developed market equity prices are overvalued and many believe a correction is fairly imminent. By building up positions in emerging markets, private equity can achieve diversification and tap into unspoiled, growing industries promising decent returns. In an environment where firms are trying to set themselves apart from the rest, emerging markets makes for an interesting investment proposition for investors.
Getting first hand on the ground experience and leveraging trustworthy local relationships is critical. To learn how SS&C can help position private equity firms for success in emerging markets, contact us at email@example.com.
 Bain & Company (2018) Global Private Equity Report 2018
Alternative Investments, EMEA