August 9, 2012
Interviewed by: David Snow
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How Is Emerging Markets PE Performing?

The International Finance Corporation has been among the most significant backers of private equity funds in emerging markets. How has the IFC been rewarded by way of returns? Umberto Pisoni, Global Portfolio Head in the Private Equity & Investment Funds Department of the IFC, says his portfolio has generated a net IRR around 20%, mostly due to the performance of first-time managers in under-penetrated markets.

In a conversation with Privcap CEO David Snow, Pisoni shares statistical findings from the IFC’s private equity portfolio.

The International Finance Corporation has been among the most significant backers of private equity funds in emerging markets. How has the IFC been rewarded by way of returns? Umberto Pisoni, Global Portfolio Head in the Private Equity & Investment Funds Department of the IFC, says his portfolio has generated a net IRR around 20%, mostly due to the performance of first-time managers in under-penetrated markets.

In a conversation with Privcap CEO David Snow, Pisoni shares statistical findings from the IFC’s private equity portfolio.

David Snow, Privcap: We are very pleased to have Umberto Pisoni from the IFC here today. You are, of course, the global portfolio head for the IFC. And, therefore, you oversee investments in many different funds across the world in the emerging markets.

Therefore, I’m very interested to hear your macro analysis of what’s going on in the world of private equity emerging markets. But maybe we could start with performance. We can talk about longer-term performance, but why don’t we start with what’s been happening over the past few years, certainly very interesting times in general, but I’m interested in what you know about the performance of these private equity investments across the emerging markets from your own data.

Umberto Pisoni, IFC: Thanks for having me here. Our portfolio is very diversified. Globally, we have about 180 funds across all geographies. So we’ve seen what’s been happening to the performance.

I’ve been tracking it lately. There have been a couple of things which have shown that the performance of emerging markets is more correlated to the various indices than we thought, and in the past. This is due to a couple of things.

The first one is the fund managers over the last few years have all switched to mark-to-market following IFRS and fair market value valuation. And with the drop, particularly in the last quarter of 2011, in the stock markets, in most emerging markets, as well as developed markets, we’ve really seen the trend where all the valuations of the portfolio companies were following the same path. And so then they’re also been rebounding now. But there’s increased correlation, more so than in the past, as I said, I think partly due to the mark-to-market.

Snow: So you’re saying that in the emerging market– is this trend more pronounced in the bigger– the BRIC countries?

Pisoni: Right. Exactly. Because you have the effects, like the drop in the Brazil Exchange. Therefore, the fund managers are pretty active in marking down their assets, based on no multiples in their comparable markets. The smaller markets where there’s less liquidity and less available benchmarks, you see adjusting a little bit slower.

Snow: Well, can you give a bit of a longer-term view? I mean, how have the private equity funds in your portfolio, again exclusively devoted to the emerging markets, been doing over the longer term? Is it a happier story than what’s been happening over the short term?

Pisoni: Right. It’s been a great story. And the numbers– we change them a little bit every quarter, because we look at what happened. But the latest numbers we’re looking at where performance of our overall portfolio in the 19% to 21% range. IRR for all the funds that we invested from 2000 onwards.

Net to IFC. So that’s a great performance. Our portfolio’s a little idiosyncratic and there’s great variation in returns. So we have everything from the 100% IRR on funds like the first CDH fund in China, which is one of the stellar performers, I think, in the private equity world and anywhere, to some really under-performers in more difficult markets with poor choice of managers. So the variation is great, but the average has actually been pretty good.

Snow: There was a moment in the early 2000s, maybe even going into the mid-2000s, where the data on emerging markets private equity fund performance was number one, not very robust, and number two, what you knew about it was not very impressive. What do you think changed between that time– maybe 10 years ago– until now?

Pisoni: Well, you have data providers like Cambridge Associates who do a great job of aggregating performance results across all geographies. I think there’s this sample– it may not be so statistically significant in each market– when it’s too small, but overall, it’s a pretty solid base now.

So we have much better base to judge the performance overall. So we can actually benchmark ourselves to top quartile. And we are in the top quartile of the Cambridge index for emerging markets.

Snow: Do you see any trends by region in your portfolio? Are there certain parts of the world are performing better than other parts?

Pisoni: In each region, there’s usually one or two outliers that give you good performance, no matter what, independent of the micro story. But obviously, East Asia has had such a growth pattern over the last 10 years that most funds have done well. So our East Asia portfolio has been well performing.

More interestingly, we just scaled up our private equity commitments to Africa over the last five, six, seven years. And those have also been performing very well. Partly, because maybe it was an under-penetrated market. We went in with some of the first movers.

So the returns have been very good. I hope they continue to be for us. It’s an important region from a strategic point of view from the mandate of IFC.

But Africa and East Asia, I would say are the two with the strongest performance. Latin America, not so much, although we have some funds that have done very well. So we’re very pleased.

Same story with Eastern Europe and Russia, on average not very good returns, but individual funds, phenomenal track record.

Snow: Would you say also that the sort of exceptional under-performers, it’s not really regionally focused but it’s more having to do with the managers themselves?

Pisoni: I don’t think we have enough data for the Middle East, North Africa region, or the COMESA region, because we have started investing there more recently. There, there may be a macro trend. This has been a more difficult region. But other than that, no, it’s more manager specific, yeah.

Snow: The IFC obviously has spent many years as a provider of capital to emerging markets funds and not only have you sat in on many pitch meetings, but many of your colleagues have as well, and you share stories. What has stood out as sort of common mistakes that GPs from around the world make when they come to you and ask your support.

Pisoni: Right. So I no longer sit as much in pitch meetings, because I focus on portfolio management. But some of the lessons from experience is by the time we screen the presentations, we have a pretty good sense of whether it’s a good team and it’s worth listening to. So we don’t really see mistakes, per se.

But one example of the most egregious mistake I could remember is when two partners came and they clearly were not getting along with each other. And it was clear in their interaction immediately. They would interrupt each other. They would contradict each other. And I really needed a 60-second decision for me to know that this was not going to work out. And we never heard back from them. And I don’t think they ever got funded.

Snow: So some advice you would give to new GPs is don’t argue with each other during a fundraising-

Pisoni: Don’t argue with each other. That’s right. It would be a good idea. That would be a great idea.

Team cohesion, as you know, is one of the key determinant of success. So we’re very focused on making sure that you can tell even from subtle signs in meetings. And there’s where the qualitative judgment comes in that we can make and that could really help us in the selection of good managers.

On the positive side, if you want to hear, what I’d really like to hear is a fund manager comes in and doesn’t tell us the stuff that we know. You know, the terms are very standard. The whole premise of private equity is standard. We usually know the micro-story for the region. So that’s all information that’s not relevant, at least to an investor like us, who’s quite knowledgeable with these markets and the private equity model.

What’s really important is someone developing an investment thesis and developing an investment rationale for why that thesis makes sense in that country or in that region at that time. So the growth of consumer class– you know, there’s a whole number of stores that you can tell. But if you can argue, convincing me the story, it really makes a difference.

Snow: Have you been able to notice a trend in your portfolio comparing regions where there are more first-time funds, newer regions like Africa, at least newer in your portfolio, versus slightly more mature regions– China? Does one perform better than the other? I would imagine that one view of it could be that because a more mature market has more experienced managers and therefore the performance tends to be more steady. But then, the other view is a newer region is under-penetrated and they’re sort of getting the lower hanging fruit. So what do the facts say?

Pisoni: So as you may know, I have ceased– we’re pushed because of our being development bank, being development institution– we’re pushed into working more and more with emerging managers– first-time managers even, as long as you can prove some track record– and this is very painful to us when we look a it from a purely commercial point of view.

Because we think well, this is a risk here, and it’s unproven and we may not get the good returns. And we cannot invest in Fund Three and Four with teams that we know well, they’re well established.

But a very interesting comment by a very sophisticated, large [INAUDIBLE] fund. I was talking to a while back was actually, these guys when they raise Fund Three and Fund Four, there’s a whole set of different– maybe their fund has becomes too big. Maybe the senior partners are no longer aligned as much as they were with Fund One and Fund Two. And sure enough, we have proven that our returns with first time or emerging managers are actually better than some of the more mature funds.

Snow: Final question. Do you think your organization has gotten better at– since you do back so many first time managers– understanding or predicting the likelihood of success from those managers?

Pisoni: I think we have a very strong team with a lot of experience in private equity. And we’ve really been able to build this sort of in-house know-how. And we have the ability to pick teams just beyond the due diligence checklist by looking again at things like– qualitative things, like does is the team can work together? Is there a track record and relevant experience to what they want to do in this market? Do they have financial skills that operate work in certain markets? We have operational skills that work in other markets. So that I think we have that extra ability.

Snow: Many people are now investing in the BRICs and the better-known and the bigger emerging markets. Yet, the core mandate of the IFC is to really push out to some of the frontier markets. Can you talk a bit about how that mandate has evolved and what kinds of countries you’re now investing in.

Pisoni: Right. So we’ve really started moving away from the BRICs. The traditional larger funds do more frontier markets. And frontier markets, we define, not just markets other than the BRICs– it’s really the real frontier. And its markets like Bangladesh, Sri Lanka, even a fund in Nepal that we’ve done recently.

So those are regions where we started really investing more recently. Our portfolios actually heavily skewed towards the BRICs, historically. So it’s too early to tell, for how the results are going play out. But we really hope that they perform as well as some of the early successes.

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