Passages

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.

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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

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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).

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

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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).

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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.

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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.

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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.

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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.

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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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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 2019, all rights reserved.

 

Questions of Leadership

“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

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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.

CrowdinginoroutVertical

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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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.