August 1, 2012
Interviewed by: David Snow
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LPs and Liquidity in Brazilian Private Equity

Duncan Littlejohn, Managing Director for Latin America at Paul Capital and a Board Member of ABVCAP, details the distinguishing characteristics of the Brazilian LP community, including veto rights and seats on the investment committee, and why the industry lacks long track records despite “great case studies and home runs.” Other topics include the evolving process of local LPs allocating to private equity, secondary activity among Brazilian funds, and the key objectives and accomplishments of ABVCAP, Brazil’s national private equity and venture capital association.

Duncan Littlejohn, Managing Director for Latin America at Paul Capital and a Board Member of ABVCAP, details the distinguishing characteristics of the Brazilian LP community, including veto rights and seats on the investment committee, and why the industry lacks long track records despite “great case studies and home runs.” Other topics include the evolving process of local LPs allocating to private equity, secondary activity among Brazilian funds, and the key objectives and accomplishments of ABVCAP, Brazil’s national private equity and venture capital association.

Privcap: What are some distinguishing characteristics of Brazil’s LP market?

Duncan Littlejohn, Paul Capital: Well, a couple of things I would say. First, in terms of governance, Brazilian LPs are looking for a more active role. They’ve been, historically, requesting a seat on the investment committee. This has been– relatively few LPs have been active in terms of the pension funds. A fairly small number has been active in private equity as well as the BNDS and FINEP. But typically they have been asking for a seat on the investment committee and veto rights.

On the other hand– and that will probably change a little as they go forward. Because as smaller LPs become interested in private equity, it clearly won’t be possible to accommodate them all on the investment committee. And there were already some conversations within ABVCAP to ventilate and sort of push the concept of an advisory committee that serves many of these purposes as well.

There’s also another difference with regard to local LPs and it has to do with economics. Local funds have different economics. They tend to be a little less generous to the GP. Some of the examples are there’s typically no catch up in local GP economics. And there is a hurdle rate, which is generally inflation-based. So you have full inflation plus a hurdle rate that has ranged up from 8% to 10%. It’s not unusual to see 10% as the net hurdle rate.

Privcap: What kinds of questions do foreign LPs have about the Brazilian market?

Littlejohn: Obviously they want to get comfortable with the macro situation and the opportunity set around that. And most of them have. That has to do with the shifting demographics and the increasing amount of disposable income in the newly minted middle class and all the opportunities that that generates. So on that side, they’re pretty comfortable.

The next thing that they want to look at is manager selection. And they want to see track records. And that’s where a lot of them have trouble. Because this industry is fairly young. It began in the ’90s. It had a serious lull in the early 2000s. And as it exists today, it was really born again in the mid 2000s. So we really don’t have very long track records.

There are some groups that have been around longer than others. There are some great case studies and home runs. But it’s hard to say that the industry as a whole has a track record. So that’s where I would say most of the LPs have some issues. They also have trouble getting comfortable with the size of the deals. Many LPs need to write larger checks than the local funds can absorb.

Privcap: What are some issues for Brazilian investors looking to being allocating to private equity?

Littlejohn: I think that it’s just a process. It’s a process that evolves. If you think about where local LPs, and let’s just say the pension funds that haven’t been active in private equity, they’ve been allocating, historically, most of their resources to government fixed income paper. Which is often inflation index. So to get comfortable with equities is a fairly– involves a learning curve.

And then to get comfortable with equities that aren’t liquid and J curves and carrying assets in your book for a long time without seeing a lot of movement in it is a little difficult for them. So they just have to get comfortable with it. They have to familiarize themselves with the success stories. And that’s part of what we do here at ABVCAP is try to spread the gospel in that regard.

Privcap: Is there a demand to buy into Brazilian funds on the secondary market?

Littlejohn: Well, there’s a demand. Yeah, secondary funds are looking for those kind of opportunities. And Brazil is not an exception. The secondary business, by nature, tends to be opportunistic. So you can’t knock on the doors and find people that are going to be sellers of secondary opportunities. So it’s really a matter of time.

People become sellers as funds become mature. And that is beginning to happen. As I said, around 2005 onward, you began to see some significant fund raising. Some of those funds are either reaching the end of their life cycles. Or they’ve distributed most of what they’re going to be distributing. So it becomes interesting for those LPs to consider an exit through a secondary market.

Privcap: What are some key priorities for ABVCAP right now?

Littlejohn: We have, on the regulatory side, we have some objectives. We’re looking to join the two regulations that basically regulate venture capital funds and private equity funds that would simplify the bureaucracy around the formation of new funds. There is the constant mission of educating our constituency and would-be constituency as to the benefits of private equity. And in this regard, we reach out to foreign LPs that are not investing in Brazilian private equity, to foreign LPs that are, to local LPs that aren’t yet in investing in private equity. So there’s a lot of work to be done in that regard.

There’s some work to be done in the sense that, I think, for a lot of players in the ecosystem, it would be very interesting for local and foreign LPs to invest together. I know that foreign LPs would gain a lot of comfort from that. And certainly GPs would like to increase their investor base and not have to take a choice of which way we’re going to go. And that’s something that more discussion, more events, more symposiums, more meetings among LPs, and more participation of smaller local LPs should eventually pave the road for that to happen.

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