Trillions

There was a bit of a disconnect at the IFC / EMPEA Global Private Equity Conference last week.

On the one hand, there was much discussion about the need to mobilize trillions of dollars to attain the Sustainable Development Goals. A burning desire to deliver impact *at scale.*

On the other, some of the event’s keynote speakers suggested it may be prudent to tilt toward a more artisanal approach to investing and development.

To wit, Raghuram Rajan examined how the agglomeration of decision-making authorities at the national and international levels disempowered localities. An emphasis on market and country-level outcomes has devastated numerous communities, leading to a hollowing out of middle-income jobs, and the emergence of “islands of underdevelopment” in industrialized economies.

As another example, Paul Collier cautioned that whilst markets can create wealth, they don’t necessarily build flourishing societies. Without a reclamation of dignity and purpose amongst the developed world’s citizens, will there be sufficient political capital to channel the trillions in financial capital that the cognoscenti deem necessary to generate prosperity in emerging markets?

As I reflected on Rajan’s remarks and their implications for those searching for solutions *at scale,* I recalled comments that Tom Barry of Zephyr Management made during a panel on the middle market: EM capital markets have not developed to expectation, and few markets have gotten to the point where they can absorb large deals.

Where is all this money going to go?

Consider the trends that are plainly visible within the EM PE industry, particularly the concentration of capital in fewer, larger funds, mostly in Asia. We’ve already witnessed a hollowing out of middle-market investment funds across EM.

If development finance institutions pursue the mission of mobilizing trillions of dollars of private capital, do we not run the risk of exacerbating the financing gap for small and mid-market businesses — the very engines of job creation the world needs?

Alas, the much-hoped-for tsunami of capital is liable to collide with some rigid bottlenecks.

It would seem to me that we need more intermediaries — new ways to channel capital to businesses that can use financing profitably and productively. What if we set a goal around sustainably doubling the size of the EM PE industry? Or developing easier ways for global investors to deploy capital into EM funds / platforms / businesses?

Rather than scouring the earth for opportunities to write large tickets, what if we found more ways to better match the bottom-up demand for capital with its owners?

In any event, I thought it was a strong conference this year — fewer people than last year, but more energetic.

Although David Rubenstein captured the headlines with his bold call to put chips on emerging markets — the man knows how to play to an audience! — I’ll leave you with the most thought-provoking comment I heard all week.

It comes from Drew Guff: Brazil is the first emerging market to tackle institutionalized corruption, and it is at a historic turning point — one as momentous as China joining the WTO.

Alla prossima,
Mike

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Governance

Governance has been a key theme of this newsletter for some time. For good reason: it’s hard to build an enduring franchise — and a healthy industry — without good governance.

And yet, while there is a plethora of resources devoted to the topic of corporate governance in emerging markets, there has been no single publication that integrates traditional corporate governance matters with business integrity issues for the EM private markets industry.

Until now.

EMPEA’s ESG Working Group has just launched its new study, Governance in Emerging Market Private Capital. Portico was delighted to participate in the project.

The report approaches governance from a holistic perspective, providing practical guidance on the key questions that individuals should ask themselves as they develop a governance framework for their business — not only to mitigate risk, but also to create value.

Moreover, it explores governance considerations across three layers of the industry: investment funds, fund managers, and portfolio companies. These include the role and composition of LPACs, operational due diligence of fund managers, and much more besides.

To make practitioners’ lives easier, each section includes checklists that outline the building blocks of good governance, and the appendix includes a repository of resources to which individuals may refer should they wish to dive deeper into specific topics.

The feedback so far has been overwhelmingly positive, and the word on the street is that it’s a good read to boot.

You should download it, read it, and share it widely.

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Due Diligence

The Abraaj blowup was one of the hot topics at the conference last week. Less because people care about Abraaj, as such, but more because that firm’s failure is creating a lot more work for EM managers.

Consider that 44% of investors in EMPEA’s 2019 Global Limited Partners Survey report that they have requested additional information from prospective fund managers. That number jumps to 70% for DFI respondents. To hear the fund managers tell it, the figure should be 100%.

Abraaj peed in the pool.

And if recent reporting is to be believed, so did Hamilton Lane, apparently.

From Pensions & Investments:

What remains to be determined is whether the debacle will lead to investors taking a harder look at the due diligence conducted by their advisers in general and Hamilton Lane in particular. All institutional investors in Abraaj funds reviewed by Pensions & Investments had Hamilton Lane as the private equity consultant…

A source with knowledge of the situation said: “These issues were destined to come out. The holding company was toxic. … Along the way there were signs and people should have paid attention to the red flags. … It was clear Abraaj was very lackadaisical in the back office, compliance and financial reporting … but it’s hard to blame people looking backwards.”

And Bloomberg:

Five months before the events that led to the collapse of Abraaj Group, the biggest in private equity history, one of the firm’s investors was warned about putting more money in…

The email, with the subject line “Abraaj Fund 6 Warning,” alleged that the buyout firm was overvaluing holdings to falsely suggest they were profitable and to boost its track record. In addition, the email claimed, most of the deals in the pipeline for the planned fund-raising were “dead” and Abraaj knew it.

“The governance is not what it appears but employees are afraid to speak or partners entrenched so don’t speak,” the email read. “There is no smoke without fire. Be the hero in your firm and uncover the truth by asking simple questions.”

Governance and transparency are vital, as is the growing focus on ODD. But sometimes I wonder if the hulking volumes of new paperwork may be an overcorrection to compensate for a lack of common sense.

For instance, before the Abraaj saga blew up in the press, one of the largest investors in PE funds reached out to Portico for an independent opinion on Abraaj and its $6B mega fund.

Governance came up as a topic. Without doing hefty due diligence, we pointed out a few things that raised yellow flags and merited attention.

But we spent most of our time raising questions about the feasibility of a $6B fund in EM from a top-down and bottom-up perspective (we listed some of these questions back in our February ‘18 newsletter).

The only paperwork necessary for the discussion was the back of a napkin.

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Private Credit

In addition to our work on the aforementioned governance report, Portico also assisted EMPEA with a new study on private credit in emerging markets.

The publication provides an overview of the four principal strategies manifest in EM — direct lending, mezzanine, distressed debt, and special situations — while offering a compelling argument for EM private credit’s advantages relative to funds active in developed markets.

One of the nifty elements of the research process was a survey of private credit practitioners, which enabled us to compare EM private credit’s target returns, use of covenants, and use of leverage against the data we see in developed markets.

In sum, EM funds offer higher prospective returns, with stronger covenants, and much lower leverage at the portfolio company and fund levels.

Dig in and take a look.

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Bridgewater on Diversification

Bridgewater, the gigantic hedge fund, released a thought-provoking research piece earlier this year on the benefits of geographic diversification.

The paper notes that most portfolios are geographically concentrated and are “under-allocated to the emerging world” — a finding that would be no surprise to readers of this newsletter, consumers of industry statistics, or lifeforms that can fog a mirror.

In brief:

Rather than try to predict who the winner will be in any particular period, a geographically diversified portfolio creates a more consistent return stream that tends to do almost as well as whatever the best single country turns out to be at any point in time …

The geographically diversified portfolios do so well because they minimize drawdowns, creating a much more consistent return stream that allows for faster compounding.

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From the Bookshelf

The systems break, the organisations crumble, though man himself goes on; and for this amongst other reasons we must never regard these systems and organisations as being the actual end of life, the ultimate purpose of history …

[W]e shall look upon each generation as, so to speak, an end in itself, a world of people existing in their own right …

So the purpose of life is not in the far future, nor, as we so often imagine, around the next corner, but the whole of it is here and now, as fully as ever it will be on this planet …

If there is a meaning in history, therefore, it lies not in the systems and organisations that are built over long periods, but in something more essentially human, something in each personality considered for mundane purposes as an end in himself.

— Herbert Butterfield, Christianity and History (Fontana Books: 1964)

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.