Mike

Impact Investing

April 11, 2019 by Mike

The haters are coming out of the woodwork to kick impact investing while it’s down. Following the Abraaj fiasco and the sordid charges filed against Bill McGlashan, formerly CEO of The Rise Fund, people seem fairly gleeful to pronounce the death of impact investing.

I was particularly tickled reading PEI’s prognosis a few weeks back (“Has Bill McGlashan poisoned the impact well?”), which oddly failed to mention that PEI itself named McGlashan “Game Changer of the Year” in 2018.

Oops.

The pickings were so easy that even I couldn’t resist tweeting, “Spare a moment for the LPs in the Abraaj healthcare fund …” (Nobody liked it).

Look, I of all people am skeptical about the term “impact investing.” It’s super squishy.

It is manifest that large asset managers are embracing the impact label to hoover up assets and collect management fees. And, it is nauseating listening to investors whose public appearances contain little more than sanctimonious virtue signaling, and whose marketing copy makes one retch in one’s mouth.

But before everyone dances on the grave of impact investing, let’s pause at GIIN’s recent research suggesting that the impact investing market has doubled to $502 billion.

And, while the financial services industry is teeming with unethical people, let’s not lose sight of the fact that there are decent, earnest individuals in the industry who actually live and breathe an impact mission. Investors who are actually building sustainable businesses and improving lives. Most of them just are not as well known.

I was reminded of this recently after I recited the previous paragraph to a journalist whose work I respect.

“Name one,” s/he said.

“[Firm],” I said.

“Never heard of ‘em.”

Skepticism is warranted. But where, I ask, was the skepticism when the banquets and award ceremonies were being thrown, and the ingratiating articles were being written?

Maybe — maybe — people shouldn’t chase shiny objects.

Alla prossima,
Mike

———

Manager Selection

Sometimes, the asset management industry is revealed for the grand kabuki dance it is: overpaid, mostly smart people developing overly complex narratives to justify their jobs / fees.

I am no Luddite.

I value data and evidence.

But who among us can quantify the life energy that has been spent ~~datamining~~ backtesting investment strategies to uncover a finding that has no utility in the real world?

It’s not just the asset managers. Consider the lifetimes that asset owners have spent developing frameworks for manager selection, or the billions of pensioners’ dollars spent on investment consultants in a quest to pick top-quartile funds.

Loads of acronyms. Loads of analytics and equations. Loads of paperwork and spreadsheets and meetings. Countless hours nudging shapes in PowerPoint.

And then you see a chart that lays bare how silly it is to think that anybody could reliably pick winners. Dan Rasmussen of Verdad uncovered a golden nugget from the Oregon Public Employees Retirement Fund (OPERF) demonstrating that “despite 30 years of experience and the best advisors money can buy, OPERF has been unable to consistently identify top-quartile managers” (see below).

And yes, that analysis is weighed by dollars allocated, not number of commitments.

To be fair, it’s more flattering when done by the latter — which comically is a lesson the consultant (and the team?) learned for the 2019 report (see page 111).

But, it’s still less than one-quarter that fall in the top quartile. 😞

———

Winds of Change

One of the things we like to talk about around here is whether EM PE — as distinct from EM private markets — is an industry in structural decline. I’ve had too many conversations with investors lately to change my opinion. The anecdotes are becoming anecdata.

And one of the genres of marination we often ponder is the DFIs’ direction of travel on PE funds. On this ponderable, the chart below from the Independent Commission for Aid Impact’s performance review of CDC is quite telling.

Whilst CDC underwent a strategy shift in 2012, it’s rather remarkable to track the rate of change in the value of the organization’s funds portfolio (i.e., “intermediated equity”) on both an absolute (£2.6B ➡︎ £2B) and relative basis (88% ➡︎ 52%!) since 2014.

Marinate on the decline for a bit and what it suggests about industry performance. We can surmise where the preponderance of future investment flows are likely to head (hint: direct debt and equity).

Whither EM PE (ex-mega-cap Asia)?

———

My Friend Wrote a Book

This is not at all related to EM private markets, but my friend, John Gans, wrote a book about the National Security Council. It rocketed to the top of the New Release charts on Amazon a couple weeks ago.

You should buy it!

And maybe even read it!

To whet your appetite, I conducted a bite-sized interview with the author.

Thumbnail on John: Previously chief speechwriter for Defense Secretary Ash Carter, senior speechwriter for Defense Secretary Chuck Hagel and Treasury Secretary Jack Lew. He also worked with Nancy Pelosi and Hillary Rodham Clinton, is published widely, and has an MA and PhD from SAIS. Big Bruce Springsteen fan.

Mike: First, thank you for writing a book that’s less than 300 pages.

Our newsletter has readers all over the world, many of whom may not have heard of the National Security Council. Why should people read this book?

John: This is the exact reason I tried to write an accessible book. The NSC is the most important and powerful entity in the U.S. government, with the influence to shape decisions that affect the lives of people in the United States and around the world. Yet few Americans can name a single member of the staff. This book introduces readers — for the first time — to the people and the power of the NSC staff. If you’re an American, these are your staffers, you should know them, judge them, and if necessary change them.

M: You interviewed an astonishing group of people for this book, including Dick Cheney, Donald Rumsfeld, Bob Gates, Susan Rice, and H.R. McMaster. What did you learn about the nature of leadership?

J: The most important take away for me is that each of these leaders is human. At the beginning of every course I teach about how government works, I start by reminding students that they are not that different than the people sitting in the Situation Room.

Barack Obama and Donald Trump, Dick Cheney and Susan Rice, are not much different than you and me. They may like politics more and be driven by a hunger for power, but they also have good days and bad, they laugh, they feel stress, and they worry about what people think about them. One of the keys to good leadership is remembering your own humanity and the humanity of those who you want to lead.

M: Your book includes a series of case studies in which entrepreneurial civil servants develop and then sell a policy shift to the president — frequently during war or exigent circumstances.

Our clients are mostly entrepreneurs who sell people on investment strategies in emerging and frontier markets — frequently these are outside of institutional investors’ comfort zone. What made for an effective ‘sales’ technique for difficult decisions across presidencies?

J: My bet is that exigent circumstances make it easier to sell one’s ideas. After all, there are few better places to sell life preservers than on a sinking ship, and few easier places to sell an idea about war than in the Oval Office with a president who does not want to lose.

That said, as someone who has worked in government and now written a book about it, I think the critical lesson is not to count on getting lucky — always having the right idea at the right time in the right place — but rather in persisting with your core ideas and principles. Eventually the right time will come for you. And if you’re ready in that moment, you’ll win the day.

M: In my previous life working with former NSC staffers, a uniform sentiment was that personalities trump process. I’ve also found this to be a prevalent sentiment while exploring the topic of governance in EM private markets.

Did you find this to be true in your interviews and research? If so, are there processes we can embrace to insulate America and the world from the consequences of misguided personalities?

J: There is no process that can make a mediocre, misguided, or malevolent person a good one. But good process can minimize the risks posed by the middling or mischievous, and make good personalities soar.

I think a lot of process — in government, in academia, in the business world — is bad because too few people are self aware enough to know what works for them and what doesn’t.

One of the early doubts I heard in working on this book was that the individuals did not matter much to the power of the NSC. But that’s one reason why no one gets what the NSC is capable of — they haven’t spent any time figuring out what makes these people tick. That’s a lesson for understanding our government, or running one’s business.

M: Why are you so obsessed with Bruce Springsteen? Especially since Rage Against the Machine’s “Ghost of Tom Joad” is clearly the better version?

J: Fandom does not require an explanation, which is probably a good thing since love is hard to explain. But the assertion appears to answer the question: Springsteen wrote a rock song so good that a newsletter about private equity is talking about Tom Joad. How many artists can do that?

———

From the Bookshelf

… reporters, more often than not, heavily rely upon the help of powerful institutions, go through the motions of acting adversarial without affecting substance, and are distracted from the public interest by profit-minded news organizations and the changing demands for advancing journalistic careers.

— Timothy E. Cook, in Geneva Overholser and Kathleen Hall Jamieson (ed.), The Press (Oxford University: 2005))

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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.

The Great Wall of Capital

March 14, 2019March 14, 2019 by Mike

I frequently wonder, “Does it makes sense to think of EM PE as an industry anymore?”

Two recent research releases — one pertaining to fundraising and one to investment — led me to ponder this question anew.

On the fundraising side, EMPEA Industry Statistics show PE / VC funds targeting Emerging Asia have raised $152 billion over the last three years. Of that:

China-dedicated funds have earmarked $70B (N.B. this excludes government guidance funds);
Pan-Asia / regional funds have captured $57B; and,
Country-dedicated or sub-regional funds constitute the remaining $25B.

During the same period, funds targeting all other EM regions raised only $19B (see below).

Last year was a blowout, with nearly $70B raised for Asia-focused PE / VC funds, with a paltry $7B raised across all other EM regions (see below).

Asia has gone from capturing 65% of EM PE fundraising in 2012 to 91% in 2018.

Does it make sense to think of a unified industry when there’s an abundance of capital commitments in Asia, and scarcity everywhere else?

And what are these people who are throwing money at China thinking? (~75% of capital has gone to USD funds over the last three years).

This gets to point two. Bain’s Global Private Equity Report 2019 reveals that $81B was invested in Chinese start-ups in 2018 (32% of global VC capital invested).

Yet, EMPEA’s stats show only $28B in PE / VC investment in China for the year.

A gap of $53B is enormous. It may be down to methodology, but I suspect a large part of that gap is due to the wide array of non-financial investors deploying capital in the tech ecosystem (we talked about this in Sep ’17).

If, in fact, EM PE / VC funds aren’t driving the bulk of the activity in China’s new-economy businesses, then what does that tell us about the asset class as a vehicle for accessing private markets opportunities?

One thing it tells us is that the tent is getting bigger. The universe of players and strategies for EM private markets is expanding, such that it’s difficult to shoehorn the multiplicity of actors into the confines of an industry. (See, for example, our newsletter from last May).

But more to the point, I think it suggests that LPs should reconsider whether traditional asset allocation buckets are an appropriate framework for thinking about long-term investments in EM.

What do you think?

Alla prossima,
Mike

———

Очень Плохие Новости

Look, I know nothing about the incarceration of Mike Calvey and his colleagues from Baring Vostok beyond what I’ve read in the press. But I take Mike’s statements about his arrest being a well-connected businessman’s ploy to gain leverage in an arbitration dispute in London at face value.

I interviewed Mike six years ago, and initially, I held out hope that his view on the ability to do business in the market might be vindicated — that independent courts would adjudicate a commercial dispute in a “non-strategic” sector, and that he wouldn’t be locked in a cell for seemingly capricious reasons. But, increasingly, it appears like a garden-variety case of state capture.

———

China’s Private Sector

In case you haven’t been paying attention to the evolution of China’s political economy, the FT’s Henny Sender wrote two excellent articles last month that merit your consideration:

Marinate on the following quotes:

Chinese entrepreneurs will privately admit that a bigger motivation for them to sell their businesses [to PE firms] now is the loss of confidence in their own government.

The country’s entrepreneurs have never felt more threatened.

In President Xi Jinping’s China there is no such thing as a truly private company. No corporate entity can say no to Beijing, whether its ownership is in the hands of official or nominally private entities.

What are the actions of the country’s entrepreneurs telling us?

Also, Henny cites a JPMorgan statistic that reveals China’s balance of payments data can’t account for $46B in capital ~~flight~~ outflows per quarter since 2016, “suggesting wealthy Chinese are still finding ways to evade [capital control] restrictions.”

Ruchir Sharma, Head of Emerging Markets and Chief Global Macro Strategist at Morgan Stanley, once shared the helpful heuristic, “follow the locals.” If elites are seeking to get their funds out of the country, what does that tell us?

Reminder: China-dedicated PE / VC funds have raised $70B over the last three years.

P.S. According to the aforementioned Bain & Co. report, Internet / tech companies have been the principal driver of PE growth in Greater China (see below).

P.P.S. Bain & Co. say the median EBITDA multiple for deals in China’s new-economy companies is 31x. Not a typo.

———

Factfulness

John Authers had a delightful newsletter that touched upon Factfulness, the last testament of Hans Rosling, the energetic man who used bubble charts to smash preconceptions about the state of the world. John’s punchline is that everyone should probably invest more in EM. (*saved you a click*)

I was so taken by John’s write-up that I immediately purchased a copy of Factfulness and read it in a day. It’s quite fun!

Hans shared 10 “Factfulness Rules of Thumb” to help make sense of the world and its figures. And lo and behold, when I received a copy of KKR’s Annual Letter, I saw: (i) ~50 million retirees and pensioners have exposure to the firm’s investments; and, (ii) it generated ~$1.1 billion in management fees in 2018.

And then I thought: FACTFULNESS RULE #5! Lonely numbers are impressive, so get them in proportion!

Amazing. Using simplifying assumptions, on average, each pensioner is paying KKR $22 each year to manage a sliver of their retirement savings.

———

From the Bookshelf

Consider now an old man who complains
Excessively about his death to come.
Nature would justly cry out louder still
And say in bitter words, ‘Away, you rogue,
With all these tears and stop this sniveling.
All life’s rewards you have reaped and now you’re withered,
But since you always want what you have not got
And never are content with that you have,
Your life has been unfulfilled, ungratifying,
And death stands by you unexpectedly
Before the feast is finished and you are full.
Come now, remember you’re no longer young
And be content to go; thus it must be.’
She would be right, I think, to act like this,
Right to rebuke him and find fault with him.
For the old order always by the new
Thrust out gives way; and one thing must from another
Be made afresh; and no one ever falls
Into the deep pit and black Tartarus.

— Lucretius, On the Nature of the Universe (Oxford World’s Classics: 2008)

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Expectations v. Reality

February 14, 2019February 14, 2019 by Mike

One thing that never ceases to entertain me is when an institutional investor says s/he expects 3x from an emerging market private equity fund.

“We want to be compensated for the risk we’re taking.”

Makes sense.

But how is that risk measured? People don’t seem to be using a Sharpe ratio, or some such analytic that disaggregates measures of alpha per quantum of risk.

According to Aswath Damodaran, the equity risk premia between developed and emerging markets have converged since the turn of the millennium. One could argue that investors should accordingly expect a lower premium from EM PE over time.

Using the spread between U.S. Treasurys and local sovereigns for a risk premium seems lazy. Private EM companies can be better credits than the countries where they operate, and actually have a lower risk profile than publicly listed companies (e.g., mining, oil & gas).

Also, it’s 2019.

Are we going to act as if many of these countries don’t have banks, and insurance companies, and mobile network operators now? There is a lot more competition, and a lot more capital scouring the landscape for deals (much of which is neither institutional nor residing with asset managers seeking PE-like returns).

Yet these markets are dynamic, and exciting, and they present an opportunity for investors to build great businesses. It’s not like the pass-the-parcel, value-transfer game in developed markets.

To be clear, there absolutely will be EM deals and perhaps some funds that deliver ≥ 3x net DPI at the end of their life. But if you’re an institutional investor investing in institutional-quality funds, what are the odds that you’re going to pick one of these winners?

Low. In all likelihood, you’re probably going to wait until the firm has a track record and built up its back office to satisfy your trustees.

By then, said firm will have scaled and begun investing in larger companies, and the economies and sectors in which they’re investing will have evolved materially.

All of these behaviors are reasonable. But the idée fixe of getting 3x is not.

If you’re going to wait for managers and markets to institutionalize and de-risk, then you should be willing to give up some of the upside. You don’t deserve it.

How realistic is the expectation of 3x, anyway?

Take a look at CalPERS’ experience (see below). Of the 268 PE funds in its portfolio (excluding vintage years 2016-18), only two funds clear the 3x hurdle.

Only 36 funds (~13%) have delivered at least 2x. Meanwhile, 80% of the funds sit between 1x and 2x, and nearly half are valued at less than 1.5x.

And lest we forget, these are with PE firms’ marks …

We could tie ourselves in knots in a discussion over the suitability of CalPERS’ portfolio as a data set, but a bogey of 3x in EM just seems unreasonable.

New rule: stop being unreasonable.

Alla prossima,
Mike

———

Liquidity

Investors often talk about the need for private equity firms to harvest an illiquidity premium — an incremental return above that generated in public markets.

The idea makes sense …

… when public markets are liquid.

But what happens when an exchange can’t absorb trading volumes? What if it fails in its job of serving as a market maker?

You should probably ask the people who tried to sell shares of Jardine Matheson Holdings Ltd. — one of the largest listed companies on the Singapore Exchange — at the market’s open on January 24^th.

Says Bloomberg:

Shares sank just before the regular session began, with about 167,500 changing hands at just $10.99, compared with Wednesday’s close of $66.47. Jardine, the flagship investment firm of a 186-year-old conglomerate, soon recovered from the $41 billion wipeout and ended up closing 0.5 percent higher.

Selling at an 83% discount seems … not to be a great advertisement for the benefits of liquidity.

CMC Markets Singapore analyst Margaret Yang Yan is a bit more candid:

This kind of stupid mistake shouldn’t have happened in an established stock exchange. It is the largest exchange in south-east Asia … It’s ridiculous.

Also ridiculous: not putting in a limit order?

This markdown never would have happened if Jardine Matheson were a PE portfolio company. But then …

———

Sell!

The trickle of exits / distributions from EM PE funds is a fact of life. We often hear about structural reasons for this logjam — the depth of local capital markets, for example.

But, what if it has little do with EM, and more to do with dealmakers’ biases? What if (most) everyone’s actually good investing?

In “Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors,” a group of researchers analyzed 783 institutional portfolios with an average portfolio value of ~$573m. The dataset included 4.4 million trades between 2000-16.

Say the authors:

We document a striking pattern: while the investors display clear skill in buying, their selling decisions underperform substantially. Positions added to the portfolio outperform both the benchmark and a strategy which randomly buys more shares of assets already held in the portfolio … In contrast, selling decisions not only fail to beat a no-skill strategy of selling another randomly chosen asset from the portfolio, they consistently underperform it by substantial amounts. PMs forgo between 50 and 100 basis points over a 1 year horizon relative to this random selling strategy.

Basically, one way to enhance performance is to become a better seller.

Maybe this could be a new skillset to hire for? Someone who sits at the table during portfolio reviews and offers constructive comments, such as, “Maybe we should sell [company].”

Or someone who walks around the office offering a helpful feedback.

Deal Gal: This promoter is a pain in my rear. The board meetings are a shambles. He won’t listen to anything we have to say.

New Guy: Hmmm … [pauses for dramatic effect and adopts hipster podcaster voice] Have you thought about selling it?

Deal Gal: But he knows what he’s doing! If we hold on to this company for another 18 months we could be looking at a 3-bagger.

New Guy:

———

Emoji Compliance

In Portico’s first research piece, I noted that the growing costs of compliance were taxing the bandwidth of smaller fund managers, and regulatory complexity was making it more difficult for firms to raise capital.

[You can envision billionaires at mega-cap firms pulling up the drawbridge behind them as regulation stifles competition and entrenches their firms’ market position.]

Well, Kirkland & Ellis sent out an update about some recent Delaware decisions regarding text messages, personal emails, and corporate litigation that brought home how absurd the world has become.

Chancellor [Andre] Bouchard added that he often finds texts to include especially probative information, particularly when covered in emojis. In a recent decision (Transperfect), he attached significance to a smiley-face “emoticon” included in one of the party’s texts as evidence of the malign intent of the sender.

Look, I am out of my depth when it comes to the legal implications of emoticons. But what’s the over / under — in months — before a DDQ contains responses to one of the following questions:

What is your policy on emoticon use?
Have you disabled controversial emoji across all devices, messaging, and email clients?
Have you staffed up your emoji compliance function with digital natives who can discern malignant intent amongst the extant universe of 2,500+ emojis?

———

Blackstone Quits Africa

No surprises here. Secondo Il Sole 24:

Il problema, sembra, è che Blackstone non ha trovato grandi operazioni da finanziare [emphasis added]. E la competizione cinese ha complicato la situazione. Anche KKR incontrò difficoltà simili tanto da smantellare nel 2017 il team di persone dedicate al continente africano e vendere il suo unico asset in quella regione, un produttore etiope di rose.”

QED.

———

Inspecting the Books

Catalyzing private capital is one of the core missions of the development finance institutions. Oftentimes, in EM private markets, this takes the form of seeding local managers and building them into institutional-quality firms (see intro).

But, what if there were another way? One that didn’t take so long. One that evoked the spirit of a place, and its people, and it propelled you to book a ticket to visit that manager in Poland or wherever.

Then you might learn about the 1 million family-run businesses that are in need of succession planning. Or the scarcity of expansion capital in a market of ~ 40 million consumers.

You might put down some Żywiec and pierogi, and get lost in Warsaw.

You might, actually, feel alive.

Manager visits wouldn’t be like those depressing trips where you eat Panda Express in a Holiday Inn Express, and the view out your window is of a half-vacant parking lot and a highway.

The EBRD has released the longlist for its 2019 Literature Prize, and until this moment I didn’t think I wanted another job, but I will read books and tell you which ones I like if you pay me to do so.

It’s a pretty cool looking collection from EBRD’s geographies. Hope you find something you like.

———

From the Bookshelf

For the first time in my life I understood that the sense of poverty is not the result of misery but of the consciousness that one is worse off than others.

Providence is no substitute for prudence.

— Jan Karski, Story of a Secret State (Houghlin Mifflin Co.: 1944)

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Passages

January 10, 2019January 10, 2019 by Mike

Happy new year. I hope you closed out 2018 with some respite and relaxation.

Our family welcomed the arrival of a new son / little brother shortly after Thanksgiving, so I’m thrilled to be starting the year refreshed and well-rested. 👀

One delightful discovery during the sleepless nights has been Patrick Leigh Fermor’s collection of travel writings. Bleary-eyed with baby strapped to my belly, I recited lines of exquisite prose to the bambino, evoking distant lands and daring adventures from a vanished world.

Whilst following the young Fermor’s trek along the Danube toward Constantinople, memories of my own youthful journeys through Mitteleuropa often materialized.

Visions of a glorious hike through the Berchtesgaden Alps; the enveloping warmth of eiderdown on a chilly summer evening; a call to my father from a payphone to wish him happy birthday, after imbibing zwei Maßkrügen of beer.

My dad would die within three years of that call, but I can still hear the mirth in his voice. How I wish he could have met his grandsons. May they forge paths of their own.

•

It could very well be the delirium, but I’m hoping that this year will be more constructive for EM private markets than 2018 was.

I wish I had something concrete to pin my hopes on, but the sheer degree of negative sentiment is all I’ve got.

Ain’t going to be an easy row to hoe, I’m afraid. So, we might as well get on with it.

Alla prossima,
Mike

P.S. Thanks to those of you who encouraged folks to subscribe to this newsletter. Portico made a donation to Room to Read for each new subscriber, so thanks for contributing to children’s literacy.

———

Profit from Purpose

So, the President of the World Bank Group unexpectedly resigned to join an infrastructure investment firm.

Par for the course. The writing was on the wall a year ago.

(“Jim has a lot of credibility with private equity firms,” said David Rubenstein.)

In an e-mail seen by the Wall Street Journal, Dr. Kim stated:

I’ve concluded that this is the path through which I will be able to make the largest impact on major global issues like climate change and the infrastructure deficit in emerging markets.

Look. I’m sure it stinks to be working with the Trump Administration. And it’s hard to make it in DC on a net-of-tax salary of $500,600 whilst enjoying world-class benefits. From a pecuniary perspective, it’s best to hop near the market top. Now’s better than three years from now.

But may we just pause and reflect on his statement?

What, pray tell, is the point of the World Bank anymore? Why did it need $13 billion in extra capital?

And what does Dr. Kim’s early departure tell us about the ability of the Bank to mobilize private funds?

Also. I am not questioning Dr. Kim’s sincerity regarding private capital’s role in solving development challenges — even if it led to a regrettable endorsement — but given the Bank’s role in financing climate solutions and infrastructure in developing economies, don’t the optics here look a bit Swampy?

Anyway, the Bank’s next President may need to come up with a new mission statement.

Thankfully, s/he likely won’t be Jeffrey Sachs. #huawei

———

Deals!

We kicked off last year with everyone getting bulled-up on EM, and this newsletter offered some cautious optimism about the prospects for exits:

Here’s hoping that we see sustained portfolio and direct investment flows, and GPs seizing the opportunity to distribute capital back to their LPs.

Well, we know how that story played out. #sadtrombone

According to data from Thomson Reuters Deals Intelligence, EM saw a 17% reduction in the volume of completed M&A transactions. The downdraft was most pronounced in Africa and Eastern Europe — which both experienced declines of 31% — but the slowdown hit each region (see below).

Fun fact: the Thomson Reuters data show that SoftBank paid out $894m in investment banking fees in 2018.

———

Tough Crowd

Private Equity International released its 2019 LP Perspectives survey. If the 101 respondents are a representative sample — an open question — then it looks like it’s going to be another tough year on the fundraising trail for managers ex-Asia (see below).

We’ve discussed LPs’ herd behavior driving a tsunami of capital toward (large-cap) Asia several times over the years. That shows no signs of abating.

Meanwhile, capital scarcity continues to define the rest of EM. History suggests that such conditions are conducive to strong performance, but — as ever — the contrarians seem to be few and far between.

Moose Guen, CEO of MVision, provides a sobering outlook:

The interest in new markets like Latin America or Africa and even parts of Asia is extremely limited. Not because of lack of opportunity or experience, but due to local currency volatility relative to the US dollar and the net dollar returns … Over the next few years, GP headcount in those markets will be inhibited because it’s very difficult to finance them.

———

Risky Business

IFC SME Ventures teamed up with CrossBoundary LLC on a study that explores PE investing in fragile and conflict-affected situations (“FCS”) in Sub-Saharan Africa. The study reaches several conclusions that we’ve advanced in this newsletter — such as the merits of flexible mandates, financings, and fund structures — and it makes a convincing case not to invest in single-country funds in frontier geographies.

I found the most thought-provoking finding to be the determination that:

FCS funds with better net returns tend to either be highly active and in control positions on select investments or deploy standardized (but flexible) debt-like instruments to a larger group of investments … Small funds with a large array of minority equity positions can struggle to both realize liquidity and adequately manage their investments.

a03189d9-a9c4-4936-b738-8948efb3f50b — Source: IFC SME Ventures.

That said, later in the report, an analysis of 312 exits from IFC’s frontier markets PE portfolio reveals that “minority positions have performed almost as well as majority positions in terms of median gross IRR.” I wonder if the discrepancy boils down to geographies (frontier vs. FCS) or a comparison of deal-level vs. fund-level returns.

In any event, the report provides some good food for thought.

———

GP Stakes

In private equity the managers do better than the investors.

The FT recently reported on Dyal Capital and the growing business of firms investing in private equity fund management companies. In essence, the business entails taking a minority stake in the GP — providing the manager an injection of permanent capital — in return for a share of the management fees and carry.

I haven’t seen data on the volume of transactions in this space, but I observed with interest the launch of Meteor5, whose management team includes MVision’s Moose Guen. The firm invests in emerging GPs, and it strikes me that a firm like this can play an important role in seeding new managers and accelerating their time to close — all with the benefit of having visibility on the product that LPs demand.

Whilst I’ve seen EM GPs sell their franchises in whole or in part to other asset managers, I’ve not seen much along the lines of the Dyal / Petershill / Meteor5 / etc. approach.

And I think I know why.

EM PE’s industry-level performance and the harsh fundraising environment raise questions about the viability of firms raising follow-on funds and harvesting investments. How does one get comfortable estimating the terminal value of fee income + carry?

It’s all a bit of a shame, but I wonder if some enterprising, well-capitalized folks might come up with a solution.

———

From the Bookshelf

There are times when hours are more precious than diamonds.

— Patrick Leigh Fermor, Between the Woods and Water (NYRB Classics: 2005)

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Illusions and Delusions

November 20, 2018November 20, 2018 by Mike

Steve Jobs once said, “You can’t connect the dots looking forward; you can only connect them looking backwards.”

There’s a lot of wisdom in that nugget, whether applied to issues of a spiritual or temporal wavelength.

It’s also relevant to quotidian things, such as deciding which book to read. For instance, in the decade since I left SAIS, apart from a methodical reading of the Ancient Greek classics, I’ve approached my bookshelves with no real theme or objective in mind.

At least, that’s what I thought.

Whilst reading William Manchester’s droll book on the Medieval mind last week, however, I experienced an epiphany that revealed a pattern amongst the cornucopia of titles.

All these years, most of the most-enjoyable books have dealt with the theme of illusions and delusions.

They covered what Adda Bozeman, in her magisterial Politics and Culture in International History, refers to as the gap between image and reality.
(h/t Ben Welch for the recommendation).

Or, as Barbara Tuchman described it, the periods “when the gap between ideal and real becomes too wide, [and] the system breaks down.”
(See A Distant Mirror and The Proud Tower).

Basically, history is littered with episodes when the bottom falls out of everything. Foundational myths, religious and political institutions, social orders, scientific hypotheses — all have cratered in the face of discovery, new knowledge and shifting conditions. They prove to have been illusions and delusions.

Lest we think that these gaps between myth and reality are confined to the distant past, consider this remark from Alan Greenspan in 2007 (as quoted in Adam Tooze’s Crashed):

[We] are fortunate that, thanks to globalization, policy decisions in the U.S. have been largely replaced by global market forces. National security aside, it hardly makes any difference who will be the next president. The world is governed by market forces.

Oops.

Or, consider the astonishing scale and duration of the fraud that was Theranos. John Carreyrou’s riveting Bad Blood, which deservedly won the 2018 FT / McKinsey & Co. Business Book of the Year award, is replete with illusions and delusional people — including a credulous board comprised of national security cognoscenti.

Or, revisit our January newsletter (“Bulls on Parade”) in which GMO’s Jeremy Grantham and KKR’s Henry McVey were bulled up on EM. I was too. Illusion! Delusion!

If it’s any consolation, an insight from Jobs’s quote is that it’s virtually impossible to measure the size of the gap between myth and reality in real time.

But man, secondo me, it really does feel like we’re living through a period when the gap between image and reality is wide and widening, and a trapdoor is beneath our feet.

I wonder, though. Which of the foundational beliefs in EM private markets will prove to have been illusions and delusions?

A few motions to debate with yourself and others:

There is an abundance of EM companies ripe for PE investment
(h/t Nadiya Auerbach).
U.S. PE will outperform EM PE over the next decade.
LPs that have committed to mega-cap Asia / China venture will do well over the next decade.
“Impact investing” will continue to be a viable asset-gathering strategy for industrial-sized GPs if / when the yield on the U.S. 10 Year climbs north of 5%.

Anyway, our second son is arriving imminently, so this is Portico’s last newsletter for 2018.

A humble request: if you value our monthly(ish) dispatch, please share it with friends and colleagues. They may sign up for free at this link, and read previous editions here.

Once again, we’re going to make a charitable contribution for each new (human) subscriber we get between now and 30 December. We’ll be donating to Room to Read, a nonprofit active in Africa and Asia that focuses on literacy and gender equality in education.

Health and happiness to you and yours.

Alla prossima,
Mike

—

401(k)s — The Final Frontier

Private equity is one step closer to accessing the $5.3 trillion 401(k) market in the United States.

The Committee on Capital Markets Regulation has released Expanding Opportunities for Investors and Retirees: Private Equity, a study that provides the intellectual grist for legislative changes that would democratize access to direct investments in PE / VC funds.

I’m of two minds on this issue. Like, of course people should be able to invest in private investment funds. But on the other hand, there just aren’t that many great PE funds that merit one’s investment. Seems like a poor set-up for success.

Moreover, there are limits to PE’s absorptive capacity. For example, according to PitchBook, U.S. PE funds raised $275 billion in capital in 2017. If PE captured just 3% of the current 401(k) market, that’s an incremental $160 billion. Would a 60% increase in capital have a negative impact on returns?

Admittedly, this compares stocks to flows; but it’s worth asking just where all this capital would go. One thing is certain: it would generate a lot of fee income for managers.

It may have been my reading of it, but the study seems to pain itself on using historical performance data to make the case that private equity’s outperformance of public markets is akin to a law of nature. A tad overdone, in my opinion. Private equity is a market of managers; and recent research demonstrates that the persistence of fund managers’ performance is declining.

Honestly, how are retail investors going to select top-quartile managers when professional LPs fail to do so on a regular basis?

The reality is that they won’t. They’ll likely invest in the name-brand mega-cap firms that excel at gathering assets. The best-performing GPs don’t need — or want — Mom & Pop’s money.

Cui bono?

—

Future Fund

Steve Byrom — head of PE at Australia’s A$150 billion Future Fund — has something to say:

At a big picture level, this asset class is becoming less attractive … Business models aren’t sufficiently differentiated because of the number of GPs in the ecosystem and the amount of capital competing for a reasonably small number of bidders.

Great time for retail to jump in!

—

Norway on Governance

Norges Bank Investment Management made a couple appearances in the newsletter this year, most notably for calling out private equity’s lack of transparency as a principal reason for their decision not to invest in it.

And since governance has been a key theme this year (and will be at least through Q1 ‘19), I was pleased to see that Norges Bank has released three position papers on key governance issues:

The need for including industry expertise on a company’s board;
Time commitments of board members (and limitations on the number of concurrent board memberships); and,
The all-important separation of the roles of chairperson and CEO.

—

Social Capital

Chamath Palihapitiya — Founder and CEO of Social Capital + Owner of the Golden State Warriors — is an outspoken guy whom I’ve enjoyed listening to and reading over the last few years.

There was a bunch of hubbub in recent months about the exodus of employees from his firm, as well as his decision to transition from a fund structure to a holding company that will invest from its own balance sheet. I don’t know what’s fact or fiction. I don’t really care.

But since the firm is now a holding company, Palihapitiya is emulating Warren Buffett and releasing annual letters. His first letter provides a dour view on U.S. venture capital as an industry, which he colorfully describes as a “multilevel marketing scheme.” It’s worth reading. His cynicism is crisp, refreshing, and effervescent, like a chilled flute of pignoletto.

In the letter, he asserts that “the demands of innovation are going up;” it’s a conclusion that I’m inclined to believe. As I wondered aloud last month, “maybe founders with vision are the scarcest thing around.”

Palihapitiya closes with a cheeky comparison of Social Capital’s performance over its first seven years vis-à-vis Berkshire Hathaway’s. The devil’s in the footnotes, but I must say: hubris is not a good look.

—

From the Bookshelf

[T]he political and philosophic history of the West during the past 150 years can be understood as a series of attempts — more or less conscious, more or less systematic, more or less violent — to fill the central emptiness left by the erosion of theology … the decay of a comprehensive Christian doctrine had left in disorder, or had left blank, essential perceptions of social justice, of the meaning of human history, of the relations between mind and body, of the place of knowledge in our moral conduct …

[This] nostalgia [for the absolute] — so profound, I think, in most of us — was directly provoked by the decline of Western man and society, of the ancient and magnificent architecture of religious certitude … Today at this point in the twentieth century, we hunger for myths, for total explanation: we are starving for guaranteed prophecy …

It was a deeply optimistic belief, held by classical Greek thought and certainly by rationalism in Europe, that the truth was somehow a friend to man, that whatever you discovered would finally benefit the species. It might take a very long time. Much of research clearly had nothing to do with immediate economic or social benefits. But wait long enough, think hard enough, be disinterested enough in your pursuit, and between you and the truth which you had discovered there will be a profound harmony. I wonder whether this is so, or whether this was itself our greatest romantic illusion?

— George Steiner, Nostalgia for the Absolute (Anansi Press: 2004)

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Liquefaction

October 25, 2018October 25, 2018 by Mike

Liquefaction | ˌlikwəˈfakSH(ə)n | noun
a process that creates a liquid from a solid (basically)

I’ve been wrestling with the idea of entropy in international affairs for the last five years or so. During my travels to London a couple weeks ago, Brexit peppered most every conversation, and I found myself thinking about political instability and its implications for investors.

The global landscape has transformed from solid to fluid, whether at the level of the international system, the state, or the individual. While the “decline of the liberal international order” has been debated ad nauseum, it’s fairly clear that we are transitioning from the post-World War II system to a new one. The problems seem to be that: (1) nobody knows what the new system should be; and, (2) no leaders are guiding us toward one.

That may be due to the fact that national leaders have more pressing priorities. How are leaders meant to identify principles of unity amongst nations when disunity and discord are ascendant at home — and, indeed, actively stoked to win at the polls?

Our populist and reactionary politics are a symptom, not the disease. At bottom, across developed and emerging markets alike, the social contract is broken.

As bleak as things are, it’s worth remembering that one of the benefits of democratic governance is that these fissures are out in the open. People are free to talk about them. The steam can be released. Society and institutions can adapt.

So, amidst all this political instability I’m beginning to think that the greatest risks in this brave new world come from the presumption of stability where none, in fact, exists.

And while I’m at it, I detect an astonishing degree of complacency toward one market in particular: China.

According to EMPEA’s Industry Statistics, $84B of capital has been raised for China-dedicated PE funds over the last five-and-a-half years, with scores of billions in regional funds that will invest in the country.

There seems to be a presumption that, since the country and its currency have been stable, this state of affairs will continue. That’s not how things work. Everyone’s legal disclaimers say as much (“Past performance is not indicative of future results …”).

I shared my rule #1 on China last month (“nobody knows anything about China — especially me”), but China’s fragilities are increasing. And a certain someone in the White House seems to smell it.

Will the country’s political system be able to respond to current and future challenges? In a manner that’s aligned with the interests of international capital?

I have my doubts.

At the very least, confidence intervals should be adjusted.

My conclusion: the most valuable attribute in EM private markets going forward is a flexible mandate.

There will always be a place for focused specialists, especially managers who bring bona fide operational expertise and can genuinely build businesses. However, in a fluid global landscape, flexibility is key — whether geographic, along the capital stack, or even across asset classes.

It’s time to think different.

Anyway, Portico has been busy in all corners during this harvest season, but particularly in Latin America, which remains a manifestly underappreciated region (see below).

Things are also a tad hectic on a personal level, as our family’s expecting the arrival of our second son / first little brother next month. If there’s no newsletter in November, well … entropy.

Alla prossima,
Mike

—

Herd Behavior

EMPEA released its 1H 2018 industry statistics and the concentration of capital in Emerging Asia is astonishing. Across private equity strategies (i.e., buyout, growth, and VC) Emerging Asia captured $24B — 93%! — of EM fundraising in the first six months of the year (that’s up from 77% in full-year 2015).

Only $1.85B was earmarked for PE managers active in Africa, Central & Eastern Europe, Latin America, and Pan-EM.

As usual, it’s worse than it appears.

That $1.85B figure overstates the volume of U.S. dollar investors committing capital to EM managers. Consider that the largest PE funds achieving a close in each region ex-Asia raised only $382m in USD, but $1.1B in local currency vehicles (see below).

I get that political uncertainty has stalled many Latin American managers’ fundraising plans, but $24m in USD? WTF?

Meanwhile, the forward calendar in Emerging Asia (inclusive of closes in Q3) has over $50B of USD-denominated funds in market (e.g., Hillhouse, Baring Asia, CVC, PAG, TPG, etc.).

I’ve disclosed Portico’s interest, but if ever there were a contrarian play in EM PE …

—

KYC

Fred Wilson of Union Square Ventures put out a heat-seeking missile of a blog post on Sunday (Who Are My Investors?). You should read it.

Fred’s musings were prompted by a note from one of USV’s portfolio company CEOs, who said:

I need to know if any of your LPs include ………. entities/interests.

This is a super interesting and welcome development, and I think Fred’s right to conclude that the quality of a fund’s LPs will impact deal flow … at least in U.S. venture.

A few quick reactions:

The cynic in me wonders if this sentiment is a luxury of a world awash in capital. But then, maybe founders with vision are the scarcest thing around.
For all the asset managers clamoring after Millennial money with impact strategies, it’s notable that founders are saying they want to partner with ethical investors who share their values.
We’ve talked a lot about transparency and governance in this newsletter this year, and it’s intriguing to see a dialogue emerge about information flowing down to the portfolio company, and not just up to the fund.

Anyway, in case you don’t click through to Fred’s post, his bold conclusion follows:

It is time for all of us in the startup and VC sector to do a deep dive on our investor base and ask the question that the CEO asked me. Who are our investors and can we be proud of them? And do we want to work for them?

…

Not all money is the same. The people that come with it and who are behind it matter. That has always been the case and remains the case and we are reminded of it from time to time. Like right now.

—

Add-Backs

The thing about dealing with leveraged buyout firms is that you always know who the Muppet isn’t.

Let’s say you’re a leveraged lender. A Patrick Bateman clone shows up and presents his bone-colored business card along with pro forma financials showing “adjusted EBITDA” for a company they’d like to lever at 6x.

You ask some questions about his revenue growth and efficiency gain assumptions, which seem slightly … optimistic.

But also, you don’t want to get fired for turning away business from a Very Important Client Who Always Gets What He Wants.

Meh, it’s not your money.

So the loan gets funded, and some teachers’ pension in Dubuque or wherever ends up holding the paper.

A couple years later, as you’re clearing out your desk, you find Bateman’s business card and you remember the discussions about the adjusted EBITDA. And since you’ve just been fired, you have time to look up what happened to that company. Did they grow revenues? Did they capture those efficiencies?

If your research reveals anything like a recent analysis by S&P Global Ratings, you’re likely to find that Bateman’s adjusted EBITDA turned out to be slightly … optimistic.

Says Institutional Investor:

In an analysis of companies involved in deal making in 2015, S&P found that the earnings projections were unrealistically high on average across leveraged buyouts and mergers due to so-called “add-backs” — adjustments made to account for expected cost savings or an anticipated rise in revenue … Compared to companies’ projections, EBITDA … turned out to be 29 percent lower in 2016 and 34 percent lower last year.

The good news is: (1) tallboys of Tecate come with a shot of Fidencio at El Rey’s tonight; and, (2) your mom’s pension invested in the LBO fund.

So when Bateman & Co. jammed through the inevitable dividend recap, the probability of your mom living on cat food declined by a few basis points. Unlike those sad souls in Des Moines or wherever.

Every cloud has a silver lining.

¡Salud!

—

Public Companies and Short-Termism

The U.S. Federal Reserve Board conducted a study to investigate the investment tendencies of public and private firms. Using corporate tax returns, the economists determined that — contrary to popular belief — “public firms invest substantially more than private firms.”

Says the study:

Relative to physical assets, publicly-listed firms invest approximately 48.1 percentage points more than privately-held firms … predominantly driven by long-term assets: public firms invest 6.5 percentage points more in short-term assets, and 46.1 percentage points more in long-term assets than their private firm counterparts … The access to capital investment and the ability to spread risks among many small shareholders appears to facilitate heavier investments in R&D, arguably the riskiest of asset classes.

You learn something every day.

And who knew R&D was an asset class?

—

Impact Investing

I don’t know about you, but I find it a bit difficult to wrap my head around “impact investing.” The term is as slippery as a greased pig.

IFC has stepped into the breach and developed, in consultation with asset managers and investors, a set of Operating Principles for Impact Management. The draft document establishes nine principles across the following five elements:

Strategic Intent
Origination & Structuring
Portfolio Management
Impact at Exit
Independent Verification

IFC is inviting reviews from stakeholders through the end of the year, so if you have an opinion, please share it. With IFC.

—

From the Bookshelf

Thus they were able to recall the past in the hope of finding new wisdom rather than in awe of its immutable commands; they could think of the future as a time of promise rather than of certainty; and they could use the present as an opportunity for the exercise of choices rather than for compliance with preordained patterns of life.

— Adda Bozeman, Politics and Culture in International History (Princeton University Press: 1960)

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The Work

September 13, 2018September 17, 2018 by Mike

September is upon us, and Portico is marking the beginning of its third year in business. We’re not popping champagne bottles to mark the occasion, but it’s pretty dope to be here plugging away. After all, roughly one-third of U.S. businesses close within their first two years.

It’s not all peaches and cream, of course. EM PE is a hard-driving, competitive industry — and it’s one going through hard times.

During a recent discussion with a client, I shared my reservations about launching an advisory firm that caters to a shrinking industry.

“One of the challenges of managing a firm in this business,” he replied, “is that the downcycles are so brutal. Good people get discouraged waiting for the cycle to turn, and they walk.”

If the figures in this EM PE talent management survey are to be believed, fatigue with the industry explains more than 20% of staff turnover. Boy, do I feel that fatigue sometimes — and I’m not even working in an EM PE firm.

All that said, Portico’s still profitable with zero debt. We missed our (über-) aggressive revenue target, but that’s okay. It was at odds with two other goals I had for the year: launching a product (accomplished, but a serious time commitment) and making sure we had happy customers.

On the latter, we conducted a client survey over the summer to gauge our progress. The findings were favorable: all of our clients were “very satisfied” and our Net Promoter Score is maxed out at +100.

The other encouraging indicator is that all of our new clients have come through referrals.

As for new targets, I experienced an epiphany last month. It came to me shortly after I’d achieved one of my personal goals for the year (attaining two stripes on my belt in BJJ). The epiphany was this: the stripes didn’t matter. I still get crushed, sometimes even by people with less experience. The value (and the pleasure) is in the work itself.

So, no hard targets for year three. I’m going to focus on doing the work and being helpful to others.

Entrepreneurship is way overhyped, but the liberty to chart one’s course makes for a gratifying odyssey.

Two closing thoughts:

First, I’m contemplating some content ideas for year three — a podcast (I know, saturated) and / or in-depth interviews with investors, thinkers, writers, etc.

Which of the following interests you most?

Podcast exclusively on EM private markets
Podcast on EM private markets + other topics
Transcripts of interviews exclusively on EM private markets
Transcripts of interviews on EM private markets + other topics

Second, I will be in London in October. Please drop me a line if you’d like to grab a coffee.

Alla prossima,
Mike

—

Advent + Walmart Brazil

Advent International completed its acquisition of 80% of Walmart Brazil, and it’s reportedly planning to invest an additional $485m across its existing stores. As we discussed in February (Always Low Prices), Walmart’s footprint of 471 stores generated revenues of $9.4B in 2016, but delivered seven straight years of operating losses. Why? “[P]oor locations, inefficient operations, labor troubles and uncompetitive prices,” apparently.

Advent purportedly plans to convert Walmart’s hypermarket formats into cash-and-carries, a format that is growing in popularity amongst local consumers. This should help the company improve one of the 5Ps — Price — by extending steeper discounts to customers.

But I’m curious as to how Advent will address another P — Place. Allegedly, Advent does not expect to roll out new stores; how will they address the so-called “poor locations”?

No clue, but it will be one of many interesting stories to watch in Brazil in the months to come.

—

African PE: Quo vadis?

Earlier this year, EMPEA released a report on The Road Ahead for African Private Equity. It’s quite good and it contains some refreshingly candid observations on the region.

There is a compelling exhibit that hits at one of our biggest frustrations: the concentration of capital in larger segments, and the relative scarcity of capital available for small and mid-size businesses (see below).

While the chart includes only a handful of countries (and excludes South Africa), I think it’s directionally accurate — the featured countries accounted for roughly half of the investments that took place in Sub-Saharan Africa between 2015-17.

Five additional findings jumped out at me:

Growth equity deals have evaporated, declining by 45% from 2016 to 2017, reaching the lowest total since 2009.
Managers need to bring more than money to the table — operational capabilities are required.
Deal structuring needs to be more flexible and sophisticated. As one endowment representative lamented, “Many GPs are inclined to throw common equity into companies and call it a day.”
Tech-enabled business models are appearing across verticals, creating a richer landscape for VC and PE alike.
Permanent capital vehicles may be a better fit with the investable market than the traditional PE model.

—

Creador + Goldman Sachs on Asia

Brahmal Vasudevan — founder and CEO of Creador — recently shared some views on PE in Southeast Asia (where performance has been “quite poor”).

Of course, he’s talking his book at a time when Creador is marketing its fourth fund (which it will undoubtedly close at or above target).

Nevertheless, several observations jumped out at me, including:

The diversification benefits of regional funds;
The merits of maintaining discipline on fund size;
The relative scarcity of “high-quality companies that are growing rapidly and need private equity capital” in select markets; and,
The potential for adverse selection in control deals.

It’s an interesting contrast with this recent Exchanges at Goldman Sachs discussion about PE in Asia.

Goldman focuses on the “scale and sophistication” of managers, especially in China. But following all the bullishness and capital flooding into the region’s large / megacap funds, I wondered, “who’s the Muppet?”

Like, I don’t have any original insight on this. My rule #1 on China is: nobody knows anything about China — especially me.

But in my passive reading of the headlines from Zhongguo, I’m left with the impression that the winds of change are in the air. Maybe investors have grown complacent.

—

Mr. China Meets the Mekong

There are few laugh-out-loud books in the world of finance, but Tim Clissold’s Mr. China is one of them. So many instances of an investor being outwitted and outmaneuvered by a crafty operator.

One of the more memorable bits revolves around an acquisition of a Chinese brewery that (naturally) involved a joint venture partner tied to the central government. A few weeks after wiring $60 million to the JV, $58 million appeared to be missing.

Oops.

Missing funds are not at all the issue in this story about a deal-gone-wrong in Vietnam, but as I read the ~~gossip~~ piece, I couldn’t help but laugh.

I mean, it’s not funny … but it is.

Poultry firm Ba Huan JSC has sought the Prime Minister’s intervention in terminating its six-month-old investment partnership with Ho Chi Minh-based asset management firm VinaCapital. The firm said it agreed to investment terms it now claims to be unreasonable because they were initially stipulated in English.

In February, VinaCapital’s flagship fund Vietnam Opportunity Fund (VOF) had invested $32.5 million to acquire a significant minority stake in Ba Huan.

In its petition to the government, the poultry firm noted that VinaCapital is seeking an internal rate of return (IRR) of 22 per cent per year. It claims that the terms of the deal stipulate that in the event of the IRR not being met, Ba Huan will be fined or required to return the investment capital, along with a 22 per cent interest, or it must transfer to VinaCapital (or its partner) at least a 51 per cent stake in the company.

It also alleged that the partnership restricts it from engaging in any other business except chicken and eggs. Its litany of grievances includes what it claims is VinaCapital’s tendency to veto all board decisions, despite it being a minority shareholder.

So many layers.

I don’t know what’s true here … I don’t even have an opinion. I just take the chuckles when they come.

—

A Most Damning Indictment

Several years ago, I was in Marrakech for the UN African Development Forum. As I waited for a car to take me to the airport, a young man in a black suit was lingering nearby, and he was staring at me in a most uncomfortable way.

It got so awkward that I turned to him and asked:

Tatakallam engleezee?

Yes.

Hey man, how’s it going?

I am good, sir. Where are you from?

The United States.

America. I love the United States. I have applied for a fellowship there.

Where?

MIT.

MIT? Are you an engineer?

An economist. I have a master’s degree in applied economics.

Oh. Do you work for the UN here?

No. I am a volunteer. There are no jobs for applied economists in Morocco. Just with the government. I presented my thesis, which [something something labor market, econometrics, etc.]. But they don’t have any jobs. So, I want to go to America to get my PhD and find a job there. It is very nice there.

Have you been?

No.

[Chitchat about Atlanta and T.I. before car rolls up]

Now, as I rode to the airport, I thought about that young man and how frustrating it is to be underemployed — to have knowledge and skills that can be of value to companies and your country, and yet find yourself unwanted. And I thought about the fickle finger of fate that dictates the range of potential life outcomes based on where one’s born and to whom.

I thought about the PE firms pursuing higher education deals in Africa and across the emerging markets. And I thought about all these students (and their parents) paying tuition to get a handhold on the ladder to a better life, and the risk that new graduates might end up like this young man, with a degree that the market doesn’t value.

In development economics, increases in human capital are vital to long-term economic growth. But what happens if the gap between expectations and reality for newly minted college graduates becomes a yawning chasm? I think we know the answer …

Anyway, these musings came to mind recently after I read a most damning indictment of PE investments in for-profit universities. The academic study, When Investor Incentives and Consumer Interests Diverge: Private Equity in Higher Education, explored 88 investments in U.S. for-profit colleges.

What did they find? In summary, following the buyout:

Profits: ↑ by upwards of 3.3x, driven by higher enrollments (↑ 48%) and tuition increases (↑ 17% relative to mean);
Graduation rates: ↓ by 6%;
Earnings of graduates: ↓ by 5.8% relative to a mean across all schools of ~$31k;
Per-student debt: ↑ 12% relative to mean;
Educational inputs: ↓ in absolute number of faculty, with 3% ↓ in share of expenditures devoted to instruction; and,
Rent seeking: revenue from public sources (e.g., federal grants and loans) ↑ from 60-70% prior to the transaction to 80%+.

Basically, students end up paying higher prices for inferior products and shittier prospects. Presumably agriculture isn’t a popular field of study, otherwise customers would know where to find the pitchforks.

There are many interesting findings in the paper, such as the nugget that “the returns to for-profit education [for the consumer] are zero or negative relative to community college education.” So, dig in. The online appendix with even more data is available here.

Or, you can look at slides 2, 10-15, and 20 in this presentation to the NY Fed.

—

From the Bookshelf

In every venture the bold man comes off best, even the wanderer, bound from distant shores.

— Athena in Homer, The Odyssey (Robert Fagles, trans.; Penguin: 1996)

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An Extractive Industry

July 19, 2018July 30, 2018 by Mike

I remember it like it was yesterday.

30 years ago, my father — God rest his soul — dragged me to the hardware store, with the promise that yet another of my boyhood weekends would be spent “building character.”

But this weekend was different.

Instead of heading home after securing the lumber and dirt, we stopped by a Toys “R” Us.

Dad told me to look around while he spoke with a manager, and when I sauntered back to the front of the store, the manager was retrieving — ever so delicately — a Nintendo Entertainment System from a locked display case. My Dad’s outstretched hands rose to the ceiling, as if offering a prayer, ready to catch the box should the manager tumble from the ladder.

Nintendo. Humankind’s third-greatest invention (after the wheel and the Gutenberg press).

That trip to Toys “R” Us was one of the most joyful moments of my childhood. I am certain that I am not alone — Toys “R” Us was an iconic company that enriched the lives of millions of children.

And private equity destroyed it.

Let’s not mince words: leveraged buyouts (LBOs) constitute an extractive industry.

In the case of Toys “R” Us, Bain Capital, KKR, and Vornado took the company private in a $6.6B LBO in 2005. It is now bankrupt and closing all of its stores — without paying employees any severance.

In the year of the acquisition, the company generated $11.2B in annual sales, and the linked article says their biggest competitors at the time were the discount retailers Wal-Mart and Target. (Amazon’s shares were ~$35, fwiw).

Revenue was never a problem. Net sales never dipped below $11.3B (in fact they exceeded $13B between 2007-13). However, according to SEC filings, Toys “R” Us’s debt burden jumped from $1.86B at acquisition to $5.5B in the fiscal year after the deal, and annual interest expense climbed from $130m in the year of the acquisition to $400m+ beginning in 2006 (see charts). Optimizing capital structures for whom, one might ask.

The LBO firms were on the take from the get-go. According to SEC filings, “upon consummation of the Merger, [Toys “R” Us] paid the Sponsors a fee in the aggregate amount of $81 million for services rendered and out-of-pocket expenses.”

In addition, SEC filings show that between 2005-17, Toys “R” Us paid out aggregate “Sponsor management and advisory fees” of $204m. An analysis in The Atlantic suggests there may have been $128m in (incremental?) transaction fees as the company bought up KB Toys (another Bain Capital bankruptcy special) and other toy retailers.

Consider that between 2014-16, when Toys “R” Us was posting losses of $867m, $256m, and $48m, the company paid out advisory fees of $22m, $18m, and $6m. In other words, in the three years that the private equity sponsors were overseeing losses before taxes of nearly $1.2B, they still drew fees of $46m.

That giant sucking sound you hear is LBO firms hoovering out the value from a cash-generating company. One that likely could have remained a going concern, had the LBO firms not forced down such an onerous debt burden.

Again, 30,000 employees were fired without receiving severance. This is Dickensian villainy at its finest. It evokes The Ghost of Tom Joad.

The FT reports that some of KKR’s pension fund clients “are re-examining their relationship with the investment group amid anger over the treatment of workers at the bankrupt retailer.” They should.

But they shouldn’t stop there — they should re-evaluate their investments in LBOs altogether.

Here’s the dirty little secret: when pensions invest in LBO funds, they are fueling inequality.

The entire LBO model is predicated on bogging down cash-generating businesses with debt, and compelling managements’ hands to create efficiency gains (i.e., layoffs). In other words, thousands of people must lose their jobs and benefits, and be plunged into a state of precarity, in order for pensioners to remain secure in their stipends. It is absolutely zero-sum.

One of the most rigorous takedowns of the LBO model is Eileen Applebaum and Rosemary Batt’s Private at Equity Work. I highly recommend it.

Notably, one of their conclusions is that, unlike LBOs, private equity investments in small and midsize companies can drive meaningful business growth and innovation. I — and others — would argue that the opportunities for shared value creation are even greater in emerging and frontier markets.

When I came up with Portico’s ethos, I jotted down the following:

Value creation > value extraction
Build something that increases the general welfare. While there are riches to be made in value extraction, we do not believe in doing well at the expense of others. Spread dignity.

The fate of Toys “R” Us is precisely the type of BS I had in mind when I wrote those lines.

I would encourage all investors to consider the long-term consequences of the LBO model, and to eschew such extractive forms of investment.

Alla prossima,
Mike

P.S. The newsletter is taking a hiatus in August. See you in September.

—

Raising a Fund

At Portico, we believe in fund managers who are trying to build businesses and increase prosperity across the world.

In a sense, Portico was founded as an anti-gatekeeper. We believe that too many service providers in this industry operate in a black box, and that this lack of transparency ultimately hurts everyone.

With that in mind, we created the Informal Guide to Raising Your First Fund. Our goal with this product is to empower fund managers with the knowledge they need to develop an institutional-quality pitchbook. We’ve bundled it with a 27-page sample pitchbook to maximize its practical utility, and the feedback we’ve received tells us it’s equally relevant for managers raising funds III, IV, and beyond.

Given the exceedingly difficult fundraising environment, we’re pleased to announce that we are now offering it for only $149. It’s more important to us that a greater number of firms succeed — and that the industry develop — than that we sit on useful knowledge.

Invest in yourself. As our next story demonstrates, it’s only going to get tougher for EM managers to raise capital.

—

Abraaj: Redux

(For background, read parts I, II, and III)

This is way bigger an exposure than anyone expected … What is shocking is that the company invested almost 10 percent of its total assets and all their investment book with one company.

•

I am surprised that the company had more than 70 percent of its 1.5 billion-dirham investment portfolio exposed to a single fund and this was never flagged by the auditors or questioned by the shareholders.

These two quotes come from a Bloomberg article on Air Arabia’s disclosure that it faces a $336m exposure to funds managed by Abraaj.

That is a lot of granola. But it’s only part of the story.

Abraaj executed a pre-IPO investment in Air Arabia in 2007, and it secured two board seats in the process. Arif Naqvi retained his position on the board through 2017 (though he didn’t show up to the first three meetings in 2017).

Somehow, nobody seemed to see a conflict of interest in Air Arabia directing “all their investment book” to a board member’s firm?

It gets worse. The Wall Street Journal reports that, “Money originating from Air Arabia was used to replenish the [Abraaj Growth Markets Health Fund], according to people familiar with the situation. KPMG’s review of the fund didn’t mention this, one of those people said.”

KPMG, you may recall, was the firm Abraaj selected to examine the books of its healthcare fund after this whole imbroglio erupted in the press. KPMG is also the auditor of Air Arabia (among other Abraaj portfolio companies).

⁂

And then there’s the bombshell.

A separate Wall Street Journal article reveals that PricewaterhouseCoopers, a provisional liquidator for Abraaj Holdings, “have ‘been unable to obtain standalone annual financial statements or management accounts’ for the holding company, a situation they described as ‘highly irregular.’”

Absolutely extraordinary. It’s a sentence worth reading again.

According to the Journal, the PwC report goes on to say:

This lack of financial record-keeping raises the question of how the company’s directors were able to ensure the company was solvent and being effectively managed.

•

Investment management fees revenue had, for some years, been insufficient to meet its operating costs.

•

Any liquidity shortfall was largely funded through new borrowings.

Reuters reporting adds that “Abraaj’s total debt stood at $1.07 billion … including $501.4 million in unsecured debt and $572.4 million [in] secured debt.”

The launch of the $6B mega-fund may be viewed in a new light.

⁂

The whole situation stinks.

And the stink is on many hands.

Who was doing due diligence? With what documents? Where was the fund administrator?

Institutions were throwing money at Abraaj. Washington State Investment Board, for example, unanimously approved an investment of up to $250m, plus fees and expenses, in the mega-fund, “based on Abraaj’s solid overall investment performance, large, institutionalized team … [and] a consistent investment and risk underwriting process applied globally.”

During the preceding Private Markets Committee meeting, Hamilton Lane “discussed [Abraaj’s] approach to investing, reputation, culture, track record, and currency risk” and supported the staff’s recommendation to invest in the fund.

They’re not the only ones. It’s just that their minutes are public.

Consider, for example, the long list of third parties that provided Abraaj the equivalent of a Good Housekeeping Seal of approval:

Abraaj reportedly received its third A+ rating from the UN Principles for Responsible Investment last year.
Arif Naqvi was on the Board of the UN Global Compact and a Founding Commissioner of the Business and Sustainable Development Commission
He is also a member of “The B Team” — a self-appointed group of business leaders that seeks to advance ESG, etc. Literally the first challenge on their website is, “Drive full transparency: be open, transparent and free from corruption, with good governance and accountability at all levels of our organizations.”
The Harvard Business School and Kennedy School connections.
The World Economic Forum.
Gatekeepers.
Auditors.
PR firms and the press.
Etc.

If there is one lesson from this fiasco, it is that it pays to do your own work.

Also, don’t chase shiny objects.

Fin.

P.S. As we suggested in March, it appears that LPs in the Africa fund are looking for a new GP to manage out the assets.

—

Small Is Beautiful in CEE

EMPEA recently released a report on private markets in CEE and it’s really quite good. My fundamental takeaway from the report is that the region attracts little capital — between $500m and $1.5B annually between 2009-17 — but this lack of capital is why (a handful of) investors like it.

Consider that, according to the PitchBook data in the study, the median Eastern European buyout multiple between 2006-17 was 5.8x — the lowest multiple globally.

Admittedly, there were few transactions that provided data points for PitchBook, so let’s look at the other end of the spectrum: as of December 2016, EBRD’s portfolio of CEE funds — which is, like, every CEE fund ever — has delivered roughly 7.5% net across all vintages. It’s not an exceptional number, but private equity’s not about investing in an index.

Moreover, it’s not like pension funds — which aren’t pursuing EBRD’s development mandate — are doing much better. According to the American Investment Council’s 2018 Public Pension Study, the median U.S. pension fund’s private equity portfolio delivered a 10-year annualized net return of 8.6%.

Anyway, as I read the briefing, I reflected upon Portico’s thought piece from last December — Does EM PE Scale? — and decided that what’s happening in CEE is a beautiful outcome. The GPs and LPs interviewed for EMPEA’s piece seemed happy with the status quo: most investors have mistaken perceptions of the region’s risks, so they don’t invest in it; and those LPs that do invest in the region have found manager relationships they value across cycles.

Maybe EM PE is an artisanal industry.

—

Insomnolent in India

Bain & Co. released the 2018 edition of their India Private Equity Report. Lots of charts. Lots of things moving up and to the right.

Bain asked respondents to its survey, “What keeps you awake at night?”

The top three responses:

Mismatch in valuation expectations (~75% of respondents)
Challenges to maintain high level of returns (~55% of respondents)
Lack of attractive deal opportunities (~50% of respondents)

Those seem like … the core elements of running a PE business? No wonder so many Indian GPs are happy to take my calls at 2am IST — they’re not sleeping!

Funnily enough, respondents were least concerned about, “Approaching end of fund life with unliquidated assets” (~3% of respondents).

Now, Bain’s survey had 39 respondents out of a universe of active investors they estimate at 491. But I wonder, would the percentage be much different if the sample size quadrupled?

—

Turkey: Value Trap?

Last November, we asked if Turkven’s Seymur Tari was precipitating a market turn in Turkey. After seven years of declining business and consumer confidence, was the country on the cusp of a resurgence?

Well. After the latest round of elections, the president’s appointment of his son-in-law as the head of the country’s treasury and finance ministry, and changes to the rules for appointing the central bank governor, one wonders if all those assets trading at a discount might constitute a value trap.

The IMF forecasts gross external financing requirements of ~25% of GDP (equal to ~$200B) each year through 2023.

Turkey’s policymakers confront a delicate dance, indeed.

—

From the Bookshelf

There is a crime here that goes beyond denunciation. There is a sorrow here that weeping cannot symbolize. There is a failure here that topples all our success. The fertile earth, the straight tree rows, the sturdy trunks, and the ripe fruit. And children dying of pellagra must die because a profit cannot be taken from an orange. And coroners must fill in the certificate — died of malnutrition — because the food must rot, must be forced to rot.

The people come with nets to fish for potatoes in the river, and the guards hold them back; they come in rattling cars to get the dumped oranges, but the kerosene is sprayed. And they stand still and watch the potatoes float by, listen to the screaming pigs being killed in a ditch and covered with quick-lime, watch the mountains of oranges slop down to a putrefying ooze; and in the eyes of the people there is the failure; and in the eyes of the hungry there is a growing wrath. In the souls of the people the grapes of wrath are filling and growing heavy, growing heavy for the vintage.

— John Steinbeck, The Grapes of Wrath (Bantam Books: 1970)

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The Wealth of Nations

June 21, 2018July 30, 2018 by Mike

A few years ago, my wife and I enjoyed a marvelous walking safari through the bush of Tanzania.

After camping in the village of Nainokanoka, we set off early with Moloton, our Maasai guide, and we trekked amongst the buffalo, gazelles, wildebeest, and zebra on our way to a campsite at Empakaai, a gorgeous crater lake that legions of flamingos call home.

It was positively Edenic … I still can’t believe my wife did it while pregnant …

Anyway, as we walked through some of the villages, I noticed an abundance of domesticated animals grazing around the boma — cattle, goats, sheep, chickens.

Since this was a long hike, I had lots of time to get lost in thought. And I kept pondering one question: who’s wealthier, a Maasai elder or your average American?

I’ve finally written down my take on this thought experiment, which you may read at this link.

Having hit publish on the piece a day after closing on a house (and thus taking on a mortgage for the next three decades), I’ve found myself acutely sensitive to the role credit plays in the U.S. economy. This machine runs on debt … future earnings are earmarked for today’s consumption.

There have been numerous articles of late warning about an impending crisis amongst over-leveraged emerging market companies and governments. A strong dollar / dollar shortage, higher borrowing costs and roll risk are genuine challenges, indeed. As Michael Pettis warned, capital structure matters bigly (see this month’s From the Bookshelf).

However, I think the sensitivity of U.S. households to rising rates is underappreciated. Personal consumption expenditures constitute nearly 70% of U.S. GDP. With higher interest expenses and higher prices due to “trade wars” — and with as-yet-unseen meaningful wage inflation — I think many American households are going to be wondering what happened to the purchasing power of their tax cuts. #youvebeenduped

On the other hand, I think many emerging market countries’ households have stronger, more resilient balance sheets. See, for example, our Maasai elder:

According to EMPEA statistics, only $5 billion was raised for EM PE / VC funds ex-Asia last year, and a measly $397 million in Q1 2018.

The scarcity of long-term capital flowing to these markets tells me that few investors see the world this way. And that may suggest we’re on the cusp of one of the most promising moments for wealth creation that EMs have seen in the last decade.

Have a great summer.

Alla prossima,
Mike

—

Mekong

Vietnam has been one of the hottest markets of late. Understandably so! It’s an alluring country with tremendous energy.

Chris Freund, founder of Mekong Capital, has been working and investing in Vietnam since the U.S. embargo was lifted in 1994. He has written a refreshingly candid piece on the origin and evolution of his firm, and its role in the development of Vietnam’s private sector.

While the article provides lessons that the Mekong team learned across multiple funds — the perils of strategy drift, the challenges of building strong management teams — it’s also a chronicle that can be read as an embodiment of EM PE’s evolution over the last two decades.

Mekong reportedly plans to go to market with Mekong Enterprise Fund IV.

I wish them well.

—

LP-GP Fit

The majority of times I meet with GPs, they’re eager to start pitching — which is often why we’re meeting in the first place and is an exciting part of my job. But I usually like to ask if I can talk to you about Sapphire first to give an overview of who we are what our investment thesis is.

That way, we can find out early in the conversation if there is alignment between the fund you’re raising and what we’re investing in. If there isn’t alignment, you’ve just been spared making your well thought out pitch only to find out that your fund is out of scope for Sapphire. Additionally, often times a LP will offer critical clues about what they care about which will allow you to tailor your pitch to what that LP cares about.

So when you walk into a meeting with an LP, pause to ask them about their business first, instead of jumping right into your pitch.

Brad Feld of Foundry Group recently circulated an article by Elizabeth Clarkson of Sapphire Ventures on the issue of LP-GP fit. While it’s focused on the top questions U.S. venture firms should ask prospective LPs, the nine questions are germane to managers of all types of vehicles, in all types of geographies.

I would encourage all GPs to read it.

Know your audience.

—

The Perils of Business Travel

So there I was — a few hours into a 15-hour flight, staring at the seat-back screen, watching as the icon of our plane crawled northwest on the map, one interminable pixel at a time. Each pixel representing some untold number of miles further from my family.

Locked in that aluminum can, arcing toward Asia at 35,000 feet, in a most calm and reasonable manner, I said to myself, “F@&! this s@&! man! F@&! it!”

It was then that I decided I was going to take a break from air travel, and I have just about reached the end of my self-imposed one-year flight ban.

It has been as great as I thought it would be.

Alas, as I began gearing up mentally to hit the skies again, I came across an article in HBR — “Just How Bad Is Business Travel for Your Health? Here’s the Data.”

The conclusions are pretty jarring:

Compared to those who spent one to six nights a month away from home for business travel, those who spent 14 or more nights away from home per month had significantly higher body mass index scores and were significantly more likely to report the following: poor self-rated health; clinical symptoms of anxiety, depression and alcohol dependence; no physical activity or exercise; smoking; and trouble sleeping.

A study of health insurance claims among World Bank staff and consultants found that travelers had significantly higher claims than their non-traveling peers for all conditions considered, including chronic diseases such as asthma and back disorders. The highest increase in health-related claims was for the stress-related disorders.

Maybe I should extend the ban …

—

Sharing Is Caring

Nearly two months have gone by, and I’m still thinking about the ODESZA concert I attended.

Their music won’t resonate with everyone, but if you’ve got a soul and enjoy funky beats, it’s pretty dope. Their jams easily boost my productivity by 33%.

ODESZA’s hitting Singapore, Jakarta, and KL in July, and the show is so good that — all protestations about air travel notwithstanding — I’m tempted to make the trip.

My only reservation is that it just takes so long to get there.

And by that I mean from Soekarno-Hatta to the venue.

There’s a 16-minute teaser of one of their earlier albums, but it’s just the tip of the iceberg. Bon appetit.

—

From the Bookshelf

Although there are significant differences from country to country and from region to region, from a corporate finance point of view these markets actually have far more in common than they have in differences, and they respond in very similar ways to external shocks …

An examination of sovereign debt history suggests that there is no obvious conclusion to be drawn about the correlation between, on the one hand, liberal economic policies and sustainable economic growth, and, on the other hand, industrial policies and economic stagnation. During periods of ample global liquidity, most economic policies seem to ‘work’ because of foreign capital inflows, while they all ‘fail’ when liquidity dries up …

The once-conventional and still dominant explanation of capital flows focuses on what are called ‘pull’ factors. This approach … argues that rich-country investors continuously evaluate profit opportunities at home and abroad and, when growth prospects in less developed countries seem favorable, they make the decision to invest … The focus of analysis is on local economic fundamentals, and the basic assumption is that improved growth prospects precede and cause investment inflows …

The alternative approach … focuses less on local economic conditions and more on changes in the liquidity of rich-country markets. It posits that when investors have excess liquidity — more than can be invested in traditional low-risk markets at home — they look elsewhere for investment opportunities … Here the basic assumption is that capital inflows precede and cause growth …

Because the lure of capital inflows is so powerful, it creates a huge incentive for local policy-makers to implement whatever development policies are currently fashionable among rich-country bankers.

I want to stress the word ‘fashionable’ because there is little historical evidence that previous policy packages that were praised and rewarded by investors were, in the end, successful in generating sustainable wealth.

— Michael Pettis, The Volatility Machine (Oxford University Press: 2001)

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Questions of Leadership

May 24, 2018July 30, 2018 by Mike

“There is no global EM champion.”

IFC and EMPEA’s Global Private Equity Conference came and went in a blur, but that comment from Nicolas Rohatyn has remained lodged in my brain. There are many ways to read it.

One is to ask: qué? There are global champions that do well in EM. Warburg Pincus comes to mind.

Equally, there are well-known champions within specific markets. A sampling from the BRICs: Pátria in Brazil; Baring Vostok in Russia; Multiples and True North in India; CDH and Hony Capital in China.

Some are less well-known. Some are in other markets. Some are up-and-coming.

Another is to ask if the issue is the lack of a thought leader, like Jim O’Neill (“Mr. BRIC”), who can articulate a fresh vision for the attractions of emerging markets en masse. I’m a fan of Morgan Stanley’s Ruchir Sharma, though he’s a realist not an evangelist. (Maybe that’s why I like him).

Another is to ask if there can ever be a proper EM champion. Can one firm or individual credibly champion all markets at the same time? I think so, but it’s a tough task. Markets across Africa, Asia, Eastern Europe, and Latin America are often at different points in the cycle, with idiosyncratic risks that defy generalization.

Rohatyn’s comment came during a panel titled Global Private Equity Leaders on the State of the Industry. The panelists included a few traditional PE funds (Africa, India, global), but also an energy investor, an Asia credit specialist, and Rohatyn’s firm, an EM hedge fund that acquired a global PE firm (CVCI), as well as EM-focused infrastructure and real estate platforms.

If it’s an uphill battle selling the complexity of EM as a geography meriting investment, is it more so when a discussion with “private equity” leaders includes multiple asset classes?

In any event, if EM private markets are confronting a leadership void — and for all my quibbles it’s a view I share — then who will assume the mantle of leadership?

Alas, questions of — and questionable — leadership were top of mind last week, and they infused the four key themes that I took away from the conference:

Crises of Governance
Managers not Markets
Sustainability Now
DFIs and the Mid-Market

Before you jump to the write-ups, this is the last blast before the new General Data Protection Regulation (“GDPR”) goes live.

Our policy is simple: we will not send this newsletter to people who have not confirmed that they would like to receive it.

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Thanks for reading and sharing!

Alla prossima,
Mike

—

Crises of Governance

Piggybacking off of last month’s newsletter, governance — or the lack thereof — was the biggest theme I observed throughout the conference, and this was on display across three levels of analysis: the individual / firm, the state, and the international system.

At the individual / firm level, there were numerous discussions about corporate governance, alignment of interests, and deal / fund terms and structures. However, the most powerful comment came from Jim Yong Kim, who said to David Rubenstein, “The biggest problem is the explosion of aspirations around the world.” Relative deprivation amidst a global political awakening is a potent cocktail for radicalization and unrest.

Ellen Johnson Sirleaf and Mo Ibrahim provided some memorable commentary bridging the firm and state levels. Madame Sirleaf implored, “It is the responsibility of shareholders to use their boards to ensure transparency and accountability, and improve corporate governance.” Ibrahim quipped, “It’s really hard to improve public governance without improving corporate governance.”

At the international level, Ambassador Chas Freeman gave a rundown of the reasons why “risks are reallocating themselves for reasons that are structural,” and set the stage for numerous discussions about political risk.

Ambassador Freeman also introduced troglonomics to the lexicon — “knuckle-dragging mercantilism that emphasizes bilateral trade balances above all else.” It is a delightful, if depressing, addition for our times.

Freeman’s overarching thesis that “international law no longer protects the weak” evokes Thucydides — not only the Melian Dialogue (“the strong do what they can and the weak suffer what they must”), but also the “terrible chapter” on Corcyra’s civil war (see this month’s From the Bookshelf selection).

It’s hard to be constructive, and I’m generally dour on the world’s prospects in the near term. However, I am cautiously optimistic that we are on the cusp of a generational transition — from a culture of fear and anger at losing what was, to one with the confidence and energy to build what can be (h/t Sir Kenneth Clark).

Hopefully this translates to a revivification of a rules-based, harmonious international system.

🤞

—

Managers not Markets

In years past, much buzz would be made about the market du jour. Panels were populated with prospective private equity kingpins, and the audience would be serenaded with those sonorous words: structural drivers, rising middle class, boots on the ground.

There was an energy and excitement about the prospects of [pick your market]. Never mind that this frequently happened just as the market was topping. It was fun. Remember Mongolia?

Yes, there were regional panels this year (and even one on blockchain), but that invigorating splash of euphoria gave way to more measured discussions around the evolution of the industry (from private equity to private markets), the need for new metrics (on impact), and more practical issues of managing funds and investments.

All of this may be an indicator of a more institutionalized asset class; but it seems to me a subtle endorsement of the idea that it’s managers that make money for investors, not market timing.

One wonders whether it was ever sensible to hype up specific markets, particularly when there are managers that consistently do well in out-of-favor geographies. I’m reminded of a recent interview with the famed short-seller Jim Chanos:

Barry Ritholtz: The last time you and I sat down for a conversation, about three years ago, you mentioned that back in the day there were a few hundred hedge funds, and out of those, 20 or 30 were reliable alpha generators. Today, there’s 11,000 or so hedge funds …

Chanos: And probably 20 or 30 reliable alpha generators.

—

Sustainability Now

There has been a palpable shift in investor sentiment toward the importance of sustainable investing. The Sustainable Development Goals (“SDGs”) permeated many speakers’ comments, and there seems to be an effort afoot to segment “impact investing” from mainline PE, with the latter being viewed as key partners for attaining the SDGs.

Most allocators are not keen to sacrifice financial returns for “impact” — define the term as you will — but they are looking for managers that deliver responsible, sustainable alpha.

The irony is that some of these managers may very well be “impact investors!”

Nevertheless, the SDGs seem to offer the biggest tent for the array of investors seeking to do well while doing good, and it is manifestly the direction in which large institutional capital is heading.

—

DFIs and the Mid-Market

Trillions of dollars of private capital will be needed to meet the SDGs. IFC’s CEO, Philippe Le Houérou, spoke about the organization’s new strategy for mobilizing private capital, which includes working with governments to unlock investable projects, and de-risking investments for private capital.

Presumably this was the rationale behind the “DFI Leaders Panel: Moving from Billions to Trillions” — a chance to proselytize about the benefits of investing in emerging / frontier markets before a quasi-captive audience of institutional investors.

And yet, about 15 minutes into an abyss of DFI navel-gazing, a delegate from a university endowment turned to me and asked, “What’s a DFI?”

🤣

The DFIs do amazing work. But I do worry that the emphasis on mobilizing large volumes of private capital will exacerbate the financing gap for mid-market funds and businesses.

To wit, there’s scuttlebutt that some DFIs may be spending less energy on fund investments going forward. Who will intermediate capital flows to smaller companies?

We’ll see; but these discussions brought to mind two of the findings from our July 2017 report The Mid-Market Squeeze.

Basically, are DFIs catalyzing private capital into EM PE funds if: (1) their preferred ticket size is in the sweet spot of commercial investors; and, (2) most commercial LPs would not be more likely to commit to a fund < $250m in size if its investors include DFIs?

No sé.

—

From the Bookshelf

Certainly it was in Corcyra that there occurred the first examples of the breakdown of law and order. There was the revenge taken in their hour of triumph by those who had in the past been arrogantly oppressed instead of wisely governed; there were the wicked resolutions taken by those who, particularly under the pressure of misfortune, wished to escape from their usual poverty and coveted the property of their neighbours; there were the savage and pitiless actions into which men were carried not so much for the sake of gain as because they were swept away into an internecine struggle by their ungovernable passions. Then, with the ordinary conventions of civilized life thrown into confusion, human nature, always ready to offend even where laws exist, showed itself proudly in its true colours, as something incapable of controlling passion, insubordinate to the idea of justice; the enemy to anything superior to itself; for, if it had not been for the pernicious power of envy, men would not so have exalted vengeance above innocence and profit above justice. Indeed, it is true that in these acts of revenge on others men take it upon themselves to begin the process of repealing those general laws of humanity which are there to give a hope of salvation to all who are in distress, instead of leaving those laws in existence, remembering that there may come a time when they, too, will be in danger and will need their protection.

— Thucydides, History of the Peloponnesian War (Penguin Classics: 1972).

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