Is EM PE Dead?

When Portico launched four years ago, I asked “Is Emerging Markets Private Equity Dying?

There’s no need to ask the question anymore.

It’s dead.

You don’t have to take my word for it — the DFIs are telling us so.

For instance, Clarisa De Franco, Managing Director for Africa Funds, Funds and Capital Partnerships with CDC Group, recently told PEI:

I also think we will see fewer new funds emerge as fundraising becomes challenging and consolidation plays out. Our strategy now is two-fold: continue our engagement and innovation with teams that are addressing specific market inefficiencies (including first-time teams) and to back strong-performing existing GPs, with fewer new managers than previously because we believe that will help create a stronger industry that can focus on both financial and developmental outcomes.

Or, look at IFC’s recent report on EM PE funds in the era of Covid-19:

Fundraising in EMs is expected to become more challenging in the next two to three years, especially for funds targeting small and midsize companies. These funds will struggle to survive, while larger and more established funds will be less impacted but still need DFI support. The composition of the Limited Partner (LP) base in EMs will shift, with international institutional investors being constrained in their asset allocations to EMs. The life cycle of funds will see a lengthening in light of longer fundraising cycles and longer investee holding periods due to challenges in achieving exits.

(Also, Actis is eschewing the traditional PE model in favor of hard assets.)

Will there be traditional PE fund managers that raise capital in EM?

Of course.

But a vibrant, growing industry?

Forget about it.

There are capacity constraints, and there are different structures for investing in EM private companies.

Work on a Portico Pivot™️ is underway. 

* * *

 I recently recorded a podcast episode about private equity in Russia. I hope we get to release it.

During the conversation, the guest and I got to talking about the transition from the Soviet Union to what came after, and how generations experienced the shift differently. For instance, people aged 40+ often had difficulty adjusting to new conditions, while younger people benefited from a lack of habits and legacy thinking that communism had engrained in the older generations.

The discussion reminded me of a passage from Sebastian Haffner’s Defying Hitler. Recalling events in Germany in 1923, Haffner wrote:

The old and unworldly had the worst of it. Many were driven to begging, many to suicide. The young and quick-witted did well. Overnight they became free, rich, and independent. It was a situation in which mental inertia and reliance on past experience were punished by starvation and death, but rapid appraisal of new situations and speed of reaction were rewarded with sudden, vast riches.

Speaking of Weimar, the feeling that the United States is on the cusp of a crucible is palpable.

It’s banal to say that Covid-19 has been an accelerant for long-standing trends, but in the last couple of months it feels as if the fissures have broken open.

Perhaps it’s the paranoia of a c. 40-year-old American who fears getting caught flat-footed, but the international system that has defined my existence is gone, and it’s not going to be reclaimed.

The urgency to adapt is acute.

 * * *

If you are a U.S. citizen, please vote in this year’s election.

Election Day is Tuesday, November 3rd.

The website www.vote.org is helpful for finding out which voting options are available in your locality (e.g., early in-person, absentee by mail), and locating your polling place. 

Vote!

Alla prossima,
Mike


Asia

Two recent pieces on private equity in Asia caught my eye. 

1.McKinsey & Company interview with Baring Private Equity Asia Founding Partner Jean Eric Salata.

Insightful take on the deepening of the Asian market — not only in terms of the strategies and sectors that attract investment, but also in terms of the evolution of human capital and the professionalization of asset management firms. Particularly thoughtful on the necessity of infusing digital capabilities throughout one’s operations and the investment cycle.

2. BCG report on The Promise for Private Equity in Asia-Pacific

There’s not much new in it, candidly, but it rightly points out the heterogeneity of investors in private markets, and it has a useful data nugget: “As of 2018, China, India, South Korea, and Thailand all ranked in the top 10 countries globally for number of family-owned businesses with market capitalization of over $250 million.”

While Portico has been cautious on investor exuberance toward mega-cap Asia and China-dedicated funds — and we watch the dogpile into Jio / Reliance Retail quizzically — the region is core.

On this point, Benedict Evans put out a thought-provoking essay on “The End of the American Internet.” Upwards of 90% of internet users are outside of the United States; China and India have 5x as many smartphones as the USA; and, the “RoW” (largely China) accounts for nearly half of global venture investment.


Someplace Else

The placement agent Eaton Partners conducted an LP Pulse Survey in September. They asked LPs which region is home to the best private market opportunities. 

The verdict: 

  • North America — 68%
  • Europe — 18%
  • Asia — 14%
  • “Someplace else” — 0%

Josh Lerner on U.S. Venture

One of the assertions I put forward last year is that the institutionalization of U.S. venture capital is leading to less innovation.

Josh Lerner and Ramana Nanda published a paper over the summer that argues a similar point. In short:

Three issues are particularly concerning to us: 1) the very narrow band of technological innovations that fit the requirements of institutional venture capital investors; 2) the relatively small number of venture capital investors who hold and shape the direction of a substantial fraction of capital that is deployed into financing radical technological change; and 3) the relaxation in recent years of the intense emphasis on corporate governance by venture capital firms.


Stash

Sometimes it’s fun to contemplate the embedded assumptions amongst the venture community.
 
For instance, Anish Acharya at Andreessen Horowitz wrote a blurb about Stash, a fintech startup that enables people to earn fractional shares as a reward when they use the Stash debit card at a merchant (i.e., you get a slice of Starbucks stock when you purchase a pumpkin spice latte or whatever).
 
Acharya believes bringing the ‘intelligent default’ to the 401(k) — making it opt-out as opposed to opt-in — is “one of the biggest forces for financial progress.”
 
Oodles of assumptions about financialization, ‘nudge’ psychology, etc.
 
Anyway, Stash is positioned as a way to help regular people build wealth … by spending their money. (There’s a monthly fee of $1 to $9, btw).
 
At first glance, this seems like a good idea. Rather than points or cash back, why not acquire a fraction of a share of stock?
 
But if you think about it for a minute longer, you’ll realize that it ‘nudges’ consumer spending toward large, publicly listed companies, leaving smaller, privately held businesses in a lurch.


From the Bookshelf

The boy thought he smelled wet ash on the wind. He went up the road and come dragging back a piece of plywood from the roadside trash and he drove sticks into the ground with a rock and made of the plywood a rickety leanto but in the end it didnt rain. He left the flarepistol and took the revolver with him and he scoured the countryside for anything to eat but he came back emptyhanded. The man took his hand, wheezing. You need to go on, he said. I cant go with you. You need to keep going. You dont know what might be down the road. We were always lucky. You’ll be lucky again. You’ll see. Just go. It’s all right.

I cant.

It’s all right. This has been a long time coming. Now it’s here. Keep going south. Do everything the way we did it.

You’re going to be okay, Papa. You have to.

No I’m not. Keep the gun with you at all times. You need to find the good guys but you cant take any chances. No chances. Do you hear?

I want to be with you.

You cant.

Please.

You cant. You have to carry the fire.

I dont know how to.

Yes you do.

Is it real? The fire?

Yes it is.

Where is it? I dont know where it is.

Yes you do. It’s inside you. It was always there. I can see it.

Just take me with you. Please.

I cant.

Please, Papa.

I cant. I cant hold my son dead in my arms. I thought I could but I cant.

You said you wouldnt ever leave me.

I know. I’m sorry. You have my whole heart. You always did. You’re the best guy. You always were. If I’m not here you can still talk to me. You can talk to me and I’ll talk to you. You’ll see.


Will I hear you?

Yes. You will. You have to make it like talk that you imagine. And you’ll hear me. You have to practice. Just don’t give up. Okay?

— Cormac McCarthy, The Road (Vintage: 2006)


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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.

Copyright © by Portico Advisers, LLC 2020, all rights reserved.

Illusions and Delusions

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:

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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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.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.