LP Sentiment

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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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.

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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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.

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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.

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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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Bulls on Parade

January 18, 2018July 30, 2018 by Mike 1 Comment

The animal spirits are palpable. Though U.S. markets have seemed to be fully valued for some time, the price action since the ball dropped on 2018 is saying, “these go to 11.”

Jeremy Grantham of GMO captures the sentiment in his piece, “Bracing Yourself for a Possible Near-Term Melt-Up.” The punchline: Grantham says it’s possible that we’ll see a melt-up to 3,400–3,700 (!) on the S&P 500 over the next nine to 18 months. I mean, it’s possible (probable?) that we won’t, but I think he’s more right than wrong.

If you missed it, Grantham laid down a gauntlet of a thought exercise late last year: imagine that you are Stalin’s pension fund manager and you are told to generate 4.5% real returns for 10 years, or else. Where do you allocate your capital?

Grantham’s answer: EM equity. In size.

I imagine that many investors—particularly those with 7%+ return assumptions—are asking themselves the question: am I sufficiently overweight in EM?

Unfortunately, I don’t think that extends to EM private markets. However, a bull cycle in EM public markets should boost multiples and be conducive 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.

Separately, thanks to those of you who encouraged people to subscribe to our newsletter. Our plea resulted in a donation to Room to Read, so thanks for contributing to children’s literacy.

Finally, If you missed our most recent research piece over the holidays, Does the EM PE Asset Class Scale?, it’s available for free on our website.

Happy new year. Let’s make it a good one.

Alla prossima,
Mike

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McVey Calls a Secular Bull Market in EM

KKR’s Henry McVey issued his hefty investment outlook for 2018, “You Can Get What You Need.” The takeaway for readers of this newsletter is his conclusion that EM are in a secular bull market that should last for three to five years. Inshallah.

Of note, McVey ran a DuPont analysis and discovers “that operating margins are finally improving across all of EM after a five-year bear market, which is now boosting return on equity.” Commodity-related companies are a major driver of this swing, so it pays to keep an eye on commodity prices for a potential turn.

One interesting tidbit in the outlook is his forecast for private equity returns over the next five years, which he estimates will decline to 9.6% (the highest across asset classes; see below).

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Norway

No, not that story.

Norway’s $1.1 trillion sovereign wealth fund has submitted a recommendation to the finance ministry that it be given greater latitude to invest in and alongside private equity funds. This would be a fairly significant development for the private equity industry, given the volume of capital that it could unlock for the asset class.

In my dreams, I envision them building a team with a global mandate to identify small- and mid-cap managers with compelling strategies. Exploiting the advantage of being a genuinely long-term investor, and seizing the opportunity to build an edge in private markets.

But in my waking hours, I see billions flowing directly to Blackstone.

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Brazil on the Move

Brazil’s auto industry is moving product: vehicle exports are expected to hit an all-time high of 750,000 in 2017, according to reports in the FT. We highlighted the bottoming process in Brazil in our April 2017 newsletter, when we juxtaposed the contraction in consumer lending and declining retail sales in the country with the fiesta in Mexico. If one were fishing for a macro long-short idea, this might be one place to look for pairs.

More to the point, we expect some large Brazilian funds to come to market in 2018. Will investors commit, or take a pass?

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Not Interested

“Emerging market interest remained low this year.”

So concludes Probitas Partners, the global placement advisory firm, in its Private Equity Institutional Investor Trends for 2018 survey (n=98). Emerging markets are one of the least attractive segments within global private equity, with only 9% of respondents planning to focus their attention on EM this year (see below).

Managers in EM just are not a priority.

Within EM, surveyed LPs find China, India, and Southeast Asia most attractive, while ~15% of respondents express interest in LatAm and Brazil. Notably, 38% of respondents report that they do not invest in EM.

The full survey is available at this link (registration required).

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From the Bookshelf

There are Croakers in every Country always boding its Ruin.

— Benjamin Franklin, Autobiography (Oxford World’s Classics: 1993).

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Dumb Money

November 19, 2017July 30, 2018 by Mike

In last month’s newsletter, I mentioned that I would be speaking at a conference with a bunch of LPs on the topic of “Global Markets for Buyouts and VC”. I closed saying, “Here’s hoping for an interactive, no-holds-barred session.”

Suffice it to say that my hopes materialized. While discussing the performance of EM PE, one LP said:

The issue with emerging markets is these funds have often been growth equity with minority stakes. The teams have been heavy on investment bankers who don’t know how to do deals. In emerging markets, private equity is the dumb money.

Dang.

Another discussion revolved around whether EM PE is in a cyclical downturn or a structural one. LPs’ commitments are generally pro-cyclical and many herd into markets / strategies at the same time, with predictable results. If so, then—ceteris paribus—the trickle of capital flowing to EMs (apart from mega-cap Asia … more on that below) may well signal a cyclical bottoming. As one conference delegate argued, now would present an optimal time to adopt a contrarian strategy and lean into EM PE.

Two brief rejoinders: First, this is not what LPs are saying they’ll do:

Second, this just isn’t how private markets work. Even if you wanted to do so, you can’t buy the index. You have to choose a manager.

Industry cycles and macro need to be disentangled. With that in mind, my view is that the quality of the managers in the market at a given time drives flows more than macro. The nuance is that fundraising is a bit of a coincident indicator: the managers with whom LPs wish to invest frequently come to market (a) at the same time; and, (b) when investor sentiment toward the jurisdiction in question is hot.

Alas, I’m still in the camp of this being a structural downturn. A few reasons I’ve pondered this week include:

“Dumb Money”!
David Swensen’s recent remark that “the breadth of emerging markets that we were interested in 20 years ago has narrowed dramatically.”
DFIs, which historically have supported the development of the industry, are increasingly committing to later, larger funds.
The ongoing emergence of local, non-PE investors that don’t face the same return hurdles / horizons creates greater competition for quality deals.
Tech is disrupting everything; in markets with fewer, ephemeral exit channels, this is a big problem.

More importantly, Happy Thanksgiving to you and yours. One of the great bits of having a toddler is that I’m reminded daily that I have a blessed life. Thank you for being a part of it, and for welcoming this newsletter into your busy day!

Alla prossima,
Mike

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The Great Wall of Capital

Fundraising for buyouts in Asia is robusto:

Baring Asia is reportedly going to market for a $6B fund
Blackstone is reportedly marketing its first pan-Asia fund at $3B
The Carlyle Group is wrapping up Asia V targeting $5B
KKR closed on its Asian Fund III at $9.3B
MBK Partners closed Fund IV at $4.1B
TPG is targeting $4.5B for Asia VII
Warburg Pincus closed its China fund with $2B

Seven funds. $34 billion. There are others.

That is a lot of granola; it’s on par with the aggregate hauls for EM PE funds in each of the last two years.

In other news, KKR inked a deal this month with Great Wall International to bring leveraged loans to China. There’s a joke in here about Barbarians at the Gate, but I’ll stop.

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LP Views on Latin America

LAVCA teamed up with Cambridge Associates for the second time on their annual LP opinion survey. There are some interesting findings the study, such as the discovery that 53% of LPs considering a first investment in Latin America view currency volatility as the biggest impediment to investing in the region. (Recency bias?)

My favorite exhibit explores LPs’ preferred means of accessing LatAm:

Most LPs plan to access LatAm via pan-regional funds
Brazil is the country of the future …
Proportionally, more Latin American LPs expect to access LatAm PE via global funds than international LPs (statistically insignificant, but the fact that they’re close strikes me as interesting)

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Facebank

The societal parasite that is Facebook is entering the small business lending space, starting with merchant cash advances. This is a fairly fascinating development. The company has already effectively become the Internet for a large number of people; will it become a lender of first resort for small businesses? Given the vast swathes of data that Facebook collects, one might surmise that they could develop an edge in credit scoring that could benefit businesses with lower rates and Facebook with a large loan book. My interest is piqued.

In related news, EMPEA’s Q3 data show that capital invested in fintech companies through September ($416M) has already exceeded last year’s total ($379M). Aggregate fintech deal value is on track to match or exceed those for 2014 ($470M) and 2015 ($509M).

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Turkey Resurgent?

Every so often, a leader steps up and makes a bold pronouncement, and market sentiment shifts. Think of Warren Buffet going long Goldman in the depths of the crisis, or Jamie Dimon plunking $26 million of his own cash on JPM shares in February 2016 (now up ~70%).

Has Seymur Tari of Turkven made a gambit to shift opinion in Turkey? Following a summer IPO of jeans retailer Mavi, Tari appears to be getting bulled-up on the market. Last month, Tari announced that the firm plans to list Medical Park Group in an offering that could fetch $1B. (Maybe?) Moreover, Turkven is planning to execute “three to four acquisitions of $50-400 million each in 2018 … and to start a new fund of more than $1 billion in one or two years,” according to Reuters.

I admire the verve. Turkey has been in the doldrums, and local business and consumer sentiment has been in a downtrend for seven years (see below). Is the tide turning?

Turkey2

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From the Bookshelf

The quality of ideas seems to play a minor role in mass movement leadership. What counts is the arrogant gesture, the complete disregard of the opinion of others, the singlehanded defiance of the world.

Charlatanism of some degree is indispensable to effective leadership. There can be no mass movement without some deliberate misrepresentation of facts.

— Eric Hoffer, The True Believer (Perennial: 1966).

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More Dickensian by the Day

November 19, 2017July 30, 2018 by Mike

Greetings from Jakarta, home to 30 million people (metro) and half as many cars, judging by traffic. I’m nearly halfway through a circuit of Southeast Asia, where I’ve been meeting with some great managers and discussing the evolution of the region’s private markets landscape.

Over the last five years, LPs have consistently ranked Southeast Asia as one of the top two most-attractive markets for GP investment. Yet this year’s Global LP Survey from EMPEA highlights the perennial disconnect:

41% of respondents plan to begin or expand their commitments to Southeast Asia over the next two years;
However, 32% say a limited number of established fund managers deters them from investing in the region (the highest percentage of any EM region); and,
25% say the scale of the opportunity to invest is too small (also the highest percentage across all EMs).

We share a few our of key takeaways from EMPEA’s survey below, but the fundraising environment is becoming more Dickensian by the day.

In any event, I’m off for a weekend in Siem Reap to admire what Norman Lewis described as “probably the most spectacular man-made remains in the world.” Then, I’ll be heading to Ho Chi Minh City for AVCJ’s conference. Let me know if you’re in town.

If you’re interested in having Portico produce a report on the private markets landscape in Southeast Asia, then please drop me a line.

Best wishes,
Mike

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A Grim LP Survey

Some depressing reading is on offer in EMPEA’s 2017 Global LP Survey. There are a number of interesting nuggets throughout the report, but I came away with three big takeaways:

Talk to the hand — The pie of capital earmarked for EM PE is shrinking. To wit, 25% of LPs plan to decrease the proportion of their PE allocation targeted to EMs over the next two years; this figure jumps to 36% for LPs that have been active in EM PE for more than 15 years.
Show me the money — The percentage of LPs expecting at least 16% net from their EM PE portfolios has continuously declined over the last five years: from 61% in 2013 to 43% in 2017. It’s also the first year that this figure dipped below 50%.Though only 17% of respondents expect ≥ 16% net from their developed markets portfolios, I suspect the drivers of these expectations are different: in EMs, it’s a lack of distributions coupled with FX, while in DMs, a surfeit of capital and leverage is fueling frothy entry valuations.
Chasing the rabbit — It’s hard not to think LPs are exhibiting some procyclical behavior: India rings in as the most attractive market while Brazil languishes at sixth; health care and consumer goods / services rank as the most attractive sectors.
¯\_(ツ)_/¯

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A Platinum Lining?

I always make time to read what KKR’s Henry McVey has to say about the markets, and his latest report, The Ultra High Net Worth Investor: Coming of Age, is no exception.

Whereas family offices constituted 6% of the respondent base of EMPEA’s LP Survey (call it 7 or 8 respondents?), KKR surveyed over 50 Ultra High Net Worth clients (defined as investors with ≥ $30m in investable assets and including family offices). The findings should provide a modicum of encouragement to private markets fund managers, as UHNW investors have a tendency to adopt a genuinely long-term perspective, and embrace alternative assets (see charts below).

Money shot: The stock of global HNW assets stands at $60 trillion with a 5-year CAGR of 7.4%, compared to global pension assets of $36.4 trillion and a 5-year CAGR of 5.8%.

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Ahlan, Bimbo!

The Mexican behemoth Grupo Bimbo has acquired Moroccan baked goods company Groupe Adghal as its toehold in Africa. Three thoughts:

Morocco continues to serve as a popular entrepôt for PEs and corporates to access Sub-Saharan African markets.
Bimbo’s ambitions are truly global. They’ve swallowed up Thomas’ English Muffins, Entenmann’s, Arnold Bread, Sara Lee, and Boboli Pizza north of the border (wall?), and they’re planning to ramp up a growth through acquisition strategy in China.
Personally, my heart warms at the prospect of children around the world sinking their teeth into a sleeve of ¡Sponch! cakes.

Speaking of Hispanophone companies pursuing acquisitions in Africa, there was a super interesting announcement from Helios Investment Partners and the Spanish multinational GBfoods earlier this month. The firms are pursuing a joint venture to create a leading pan-African FMCG franchise. I think we’ll continue to see PE firms teaming with multinationals to de-risk acquisitions and validate their entry into new markets; it’s a compelling proposition.

Out of curiosity, I investigated the number of Hispanophone acquisitions in Africa (excluding our friends at Mediterrania Capital Partners). Across 30 deals since 2008, six have been in metals and mining, and four in F&B. Small volumes, but the trend is up and to the right (see chart below).

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The Saga Continues

Baring Private Equity Asia and CPPIB announced that they are taking Nord Anglia private for $4.3B. Baring originally took the company private in 2008, led the firm through a $350m IPO in 2014, and a $170m follow-on issuance in 2015. Over the last four years, Nord Anglia executed at least seven acquisitions, according to Thomson Reuters Eikon. The company’s revenues grew from $323.7m in 2013 to $856m in 2016, with net income swinging from a loss of $23.3m to earnings of $47.1 over the period (and posting a 17% ROE in 2016).

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Fashionably Late?

Blackstone has decided to join the private debt party in India. Apollo (through a JV with ICICI Ventures), Baring Private Equity Asia, Clearwater Capital, KKR, and Piramal—among others—have been in the mix for some time. It’s a huge market, but one wonders if the bar’s running out of elbow room.

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From the Bookshelf

A seed that sprouts at the foot of its parent tree remains stunted until it is transplanted … Every human being, when the time comes, has to depart and seek his fulfillment in his own way.

— R.K. Narayan (trans.), The Ramayana (Penguin: 1987).

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