May 1, 2012
Interviewed by: David Snow
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Emerging LPs

The emerging markets topic in private equity has mostly been one of Western capital supporting developing-economy GPs. But now, the rise of well-capitalized investing institutions across the emerging markets is beginning to shake up the status quo of the global private capital industry.

This important panel discussion includes David Marchick, Managing Director with The Carlyle Group, Maureen Downey, Principal with Pantheon Ventures, and Peter Furci, a Partner with Debevoise & Plimpton.

The emerging markets topic in private equity has mostly been one of Western capital supporting developing-economy GPs. But now, the rise of well-capitalized investing institutions across the emerging markets is beginning to shake up the status quo of the global private capital industry.

This important panel discussion includes David Marchick, Managing Director with The Carlyle Group, Maureen Downey, Principal with Pantheon Ventures, and Peter Furci, a Partner with Debevoise & Plimpton.

David Snow, Privcap: Joining us today are David Marchick of the Carlyle group, Maureen Downey of Pantheon Ventures, and Peter Furci of Debevoise & Plimpton.

We have a fascinating topic today. We’ve been talking about the emerging markets. And specifically, how investors are engaging with the emerging markets, how they’re adding emerging markets to their portfolios. Now, principally, when people talk about it, they’re talking about big Western firms, Western investment institutions. But there has been a growing trend of institutions in the emerging markets allocating to not only local private equity, but also to global private equity. So I’m interested to hear from all of you what the effect of that trend will be on the market.

Maybe starting with Peter. How important of the trend is it whereby the local LPs are allocating capital to local private equity firms, which probably, until recently, had gotten the lion’s share of their capital from Western institutions?

Peter Furci, Debevoise & Plimpton: I think it’s hugely important. What you see, for example, in China are the growth of RMB funds, which actually permit local investors to invest in China using local currency. And that’s been a huge phenomenon in China and something that we think is going to be of increasing importance.

In Brazil, for example, Brazil has a long private equity tradition. And the Brazilian pension plans have actually invested in private equity for many, many years, and continue to be a very, very important source of capital. What’s been very interesting though about some of the emerging market fund raises have been the investment by other emerging market investors in a different emerging market. For example, in some of the recent Latin American fund raises that we worked on, we saw very significant investments from China, Singapore, Middle Eastern, sovereign wealth and other investors, in addition to large Western and European pension plans. So we actually think that the global movement of capital is going to be a hugely important trend for private equity.

Snow: David, at the Carlyle group, as your firm has built out its emerging markets presence, have you seen an increasing participation of investing institutions from the emerging markets in that growth?

David Marchick, The Carlyle Group: Absolutely. We’ve seen a similar upward trajectory in terms of the amount of capital we’re investing in emerging markets, but also the amount of capital from emerging markets in which emerging market investors are investing in some of our opportunities. Not only comes from the Middle East where there’s long– there’s tradition of investing in private equity, but also in Singapore, in Southeast Asia, in China. The pension funds in a number of Latin American countries are becoming much more sophisticated, increasing their allocations to private equity. And I think you can see the growth of our investor relations team inside of Carlyle. Probably 2/3 of it is outside the United States, whereas 5, 8 years ago, it was by 2/3 inside the United States.

Maureen Downey, Pantheon Ventures: In addition to the work I do in the investment side, I’m also responsible for our business development in Latin America. And I would say that I think there’s something like 700 billion assets, AUM, within the pension funds in Latin America. Probably even a little bit more. And the estimate is that they will double in five years.

If you take, for instance– Chile, for instance, which is 16 million people, they have assets around 140 billion. And they’re literally aren’t enough assets within Chile for the pension funds to invest in. And if they did, they’d completely move the stock market there. So they can invest about 80% of their assets overseas.

This is happening across Latin America. They have very different pension systems in, say the Andean region than they do in Brazil. But I think there is a significant growth in capital. They play a very important part in funding many of the startup local GPs.

In Brazil, for instance, they’re probably in their second phase of private equity now. About 25% of the capital in private equity is from the local GPs. And I think this is particularly important because it represents a huge portion of the small and mid-market GPs in Brazil. Because most of the capital that’s been raised in Brazil to date have been from international firms coming in, who do not want local LPs in their funds because the local LPs want a seat on the investment committee.

So when you look at that 25%, it actually represents a large amount of capital for the mid and small market GPs in those countries. So clearly, going to be very important in not only the development of the local GP landscape, but also I think in just being a significant contributor to the private equity fundraising world going forward.

Furci: In particular, the Brazil pension plans are limited in how much money they can deploy outside Brazil. I believe it’s 10% basket. But when you think about the numbers that overall AUM could reach, 10% of that is still an enormously attractive prize for international private equity managers. And so I think that there will be an increased push to try to get those investors comfortable with Western style private equity, where they’re not sitting on the investment committee. They’re not really calling the shots with the local team and access some of that capital.

Downey: The one thing I would say though too, is when you talk to a lot of the investors, say in particular in Latin America, they are very attracted to the opportunity in their backyard. So it’s hard to get them excited about putting money into Europe or the US where they see the growth, frankly, is a lot lower.

The other thing I would say is that they understand emerging markets and are more comfortable with it than, say developed markets. So, if anything, when I would speak to a Latin investor, they would actually have some interest in maybe investing in Asia. So I think it’s a very different mentality and you need to be cognizant of that when you’re having those conversations with LPs in these developing economies.

Furci: Ultimately though, it becomes a diversification story for them.

Downey: It does. It absolutely does.

Furci: Where if you have 90% of your assets in a single country, to be–

Downey: It’s not good for your constituents. I mean, that would be my response as well, too.

Snow: I want to ask you a follow-up question about Latin America. But first, actually, David, since you mentioned China, in your interactions with the Chinese investors, are they primarily interested in Chinese private equity via the RMB funds, or are they also interested in, again, the broader opportunity set?

Marchick: It really depends on the institution, their appetite, their sophistication, and also the rules that govern them. So the sovereign wealth funds are interested in global exposure, and they have very, very significant amounts of capital. Then you have municipalities. They’re generally interested in RMB funds. They’re focused on developing private equity in their jurisdiction and using their wallet to create a catalyst for private equity firms to develop in their jurisdiction, also invest in their jurisdiction.

Increasingly, insurance companies and corporates are going to be large investors in private equity, and they’re increasingly looking for global exposure. The regulations still have to catch up to their appetite for exposure. But going back to something that Maureen said, if you have an insurance company with 90% of their investments in one country, they’re actually reducing risk by investing abroad, by investing in a variety of different asset classes so they can diversify their own assets. Which helps them meet their liabilities.

Snow: Back to Latin America. I can’t tell you how many times I’ve spoken to people in the past few months where I’ve tried to book a meeting with them and they’ve said, “I’m sorry, I’m going to be in Colombia.” So what are they doing there, and have you been there recently? Can you talk about that?

Downey: So, why are they going to Columbia? Well, of the LATAM countries that are– I would say the pension funds that are investing, it’s really just the Andean region right now. Mexico has some very stringent regulations where they can invest in private equity, but it’s only in private equity in Mexico. Colombia has the least hurdles in comparison to say Chile or Peru, in terms of being able to invest abroad. And so I think that’s why it makes a very attractive destination.

In Chile, there’s restrictions. You have to set up a feeder fund. There’s a regulator where you need to seek approval. So I think the reason why everyone’s going to Colombia is I think it’s less hurdles, I think, to fundraise with an international fund there.

Snow: And the Colombians want to invest outside of Colombia?

Downey: They do want to invest outside of Colombia. They have a sizable assets under management. Just to make sure that everyone’s familiar, the system, they’re called AFPs, was started in the ’80s in Chile. Chile was the designator of this type of pension where the government mandates that you put anywhere between 7% to 10% of your salary in a pension fund. You can choose, but 10% of your salary goes into a pension fund. So these pension funds will continue to increase dramatically, especially if you assume that populations are increasing. And also, the economies are getting wealthier.

So it makes it very attractive for outside capital, outside private equity funds to come to these countries. Because as their capital is growing so rapidly, they don’t have as many opportunities internally, both on the public side, but also on the private side to keep deploying assets. So they’re going to have to start investing abroad.

Furci: The other thing I’ll say about Colombia is that on the flip side of things, that with obtaining an investment grade rating and with the dramatic improvement in the security situation in that country over the past 10 years, it’s often touted as a new destination for private equity investing, not just a source of investors.

Snow: I’d like to shift gears a bit and start by playing to David’s background. You’re an expert in foreign direct investment. And so maybe we can start in Africa and talk about the fact that there are other places for growing companies to get– especially in frontier markets, to get capital, other than private equity firms, other than banks. And it’s development agencies. So I’m wondering if you can chart or explain to us the evolution of maybe certain countries and certain regions, and perhaps Africa, getting capital from development agencies. And now bumping into opportunities to get capital from other places like private equity firms. And how you think that will change the opportunity going forward.

Marchick: What we’ve seen is that as a country matures and moves up the economic development continuum, that development agencies play a less and less role. So development agencies are really– they’ve graduated from investing in South Africa. They’re close to graduating from investing in countries like Nigeria, which is a huge country, fast-growing middle class, very, very significant amounts of private sector investment.

Development agencies are mostly focused, in my experience in Africa, on smaller countries, less developed countries, many of the francophone countries. And they aren’t trying to invest in places where there’s a gap where private sector or capital can’t flow.

The other trend that we’ve seen is that development agencies are trying to use their money as a catalyst to attract private sector investment. They know that they can’t fill the need that a country has in terms of the amount of investment, the capacity, the support for institutions, support for governance. But they’re trying to use their wallet and their leverage to attract many times the amount of money they can invest themselves.

And so the African Development Bank, for example, is a very sophisticated institution. And they’re pushing private sector investors to invest, not only in places where they can serve as a catalyst, but also in the places where they no longer need to invest.

Downey: I just came back from Brazil, actually last week. And I was talking to one of the government agencies and they really are trying to create an angel community there. And so one of the things that they’ve put in place is that if you, as a, say wealthy investor, make an investment in, say an angel or a seed fund, they’ll guarantee your principal. So I thought that was kind of very interesting.

But again, it goes to trying to develop a ecosystem of private equity community. And I think that’s where they can be very helpful and very instrumental.

Snow: One more quick topic. Obviously, it’s still very important for Western private equity capital to flow into emerging markets funds. And that’s the primary direction that capital is flowing. But there is, as we discussed, a lot of capital flowing from the emerging markets back to the US. And China is a big example.

When it’s coming the other way, what are they attracted by? What is the emerging markets sourced capital attracted by in, let’s say the US? Is it the stability? What are they looking for?

Marchick: First of all, I think you still have to start with the numbers. The amount of capital in a lot of developing countries is just staggering. And the level of their outward foreign and direct investment is way behind the level of the development of their economy, the size of their economy. Just take China.

China is the second largest economy in the world, the second largest recipient of inward foreign investment, the second largest exporter in the world. Some years they’re the largest exporter. But they rank 17th or 18th in terms of the amount of outward investment below Denmark and Sweden. So the amount of capital that China can and should be investing abroad is a staggering amount. And they need to catch up. And they will catch up. So the sheer numbers will drive Chinese companies and Chinese institutions to invest abroad.

What they want is they want access to the best products, the best talent, the best brands. Obviously, they’re growing faster than we are in the West. But that doesn’t mean that there aren’t fast-growing companies in the United States or Europe that they can invest in to capture that growth and to accelerate their own growth.

One thing we’re seeing in the United States is very significant investing by Chinese companies in manufacturing, which is kind of counterintuitive because one would think, well, they have low manufacturing. They have very low wages. It would be attractive for manufacturing. But given the global supply chain and the needs for just-in-time delivery, they want to be close to the customers, which may be in the United States. And so they want to manufacture here as well.

So we’re just starting to– we’re at the tip of the iceberg in terms of the amount of money that’s going to come from China, Southeast Asia, Brazil, the Middle East into the United States and into Western Europe.

Furci: A lot of Chinese direct investment has a strategic component to it as well. We’ve worked on transactions where we’ve represented Brazilian companies who may be in a commodities business where China invests largely because they view that particular product as an absolutely essential strategic supply issue for them.

Snow: Maureen, since we’re talking about China very briefly. To the extent that Chinese capital is investing in fund to funds products or in private equity and it’s not in China, where is it going second and third? Is it the West? Is it elsewhere in Asia?

 

Downey: I think it’s diversified. I think that they are investing aggressively overseas, and it will continue. I think in addition to the points that David brought up, I think the other thing that they’re looking for quite clearly when we’ve had discussions with some of the large sovereign wealth funds is education. They want access to knowledge, training. And I would say that is across the board for all of these emerging market LP investors that they’re looking for education, too.

But it’s diversified. I think people are a little bit warmer toward the US than they are Europe. I think when you open the paper, the growth prospects and some of the dynamics in Europe appear quite a bit less favorable than say, the US. So that might be one area where they don’t have as much appetite.

Furci: Although one of my fund clients, actually first to Europe is the submerging markets. But in all seriousness, I think there is a perception that even though the growth rates are fairly low, that there is a distressed opportunity there. And we actually are seeing more funds being raised to pursue distressed opportunities in Europe and more capital from emerging markets pursuing those.

Snow: Well, it sounds like there will be much more capital flowing both from developed markets to emerging markets and back over the foreseeable future. And hopefully as that happens I can have all of you back on Privcap to talk about it. But for now, why don’t we pause. Thank you all very much for joining Privcap today.

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