Impact Investing

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

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

Oops.

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

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

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

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

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

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

“Name one,” s/he said.

“[Firm],” I said.

“Never heard of ‘em.”

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

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

Alla prossima,
Mike

———

Manager Selection

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

I am no Luddite.

I value data and evidence.

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

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

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

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

Screen Shot 2019-04-06 at 2.40.46 PM

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

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

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

———

Winds of Change

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

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

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

Picture1.png

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

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

———

My Friend Wrote a Book

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

You should buy it!

And maybe even read it!

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

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

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

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

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

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

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

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

whw

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

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

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

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

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

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

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

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

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

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

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

———

From the Bookshelf

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

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

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

Copyright © by Portico Advisers, LLC 2019, all rights reserved.

Expectations v. Reality

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.

Screen Shot 2019-02-11 at 8.29.04 AM

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 24th.

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.

Copyright © by Portico Advisers, LLC 2019, all rights reserved.

The White Stripe

A small print of Jody Clark’s “Keep Treading” hangs on a wall in my office. It’s a picture that I first saw at the Brazilian Jiu Jitsu (“BJJ”) gym where I started training last fall. It shows a man in a gi trying to stay afloat in the ocean. An eel is wrapping around his legs and pulling him asunder, while a collection of sea nettles threatens to sting him if he reaches out his arms.

It’s an apt metaphor for the travails of a white belt in BJJ. As Sam Harris describes it, “The experience … is akin to falling into deep water without knowing how to swim. You will make a furious effort to stay afloat—and you will fail.”

That is an accurate one-word summation of my first five months in BJJ: failure. Relentless, unmitigated failure. Soul- and ego-crushing failure.

Consider this dispatch from my BJJ journal:

2/10 – Open Mat

Performed poorly. Got smashed. Decent defense but too passive. Need to be more aggressive. Neck got crushed while in turtle. Honestly I just feel dejected.

There are days when the hardest thing is showing up to class or open mat. The certainty of being smashed, submitted, and in pain makes it all seem like a futile exercise. It’s so tempting to quit in the face of near-certain failure.

But, you have to keep treading. It’s all a bit of a metaphor for life as a whole.

Last week, I received my first stripe on my white belt. I know it’s foolish to place much stock in outward signs of progress, but this promotion—this piece of tape—was one of the more hard-earned accomplishments in my life. And yet, it’s merely the first rung on the ladder. Progress. One aching, small step at a time.

In other news, I’m looking forward to joining some folks from General Atlantic next month for a conversation with students at UVA’s McIntire School of Commerce. Should be fun!

I’ve also created a video of the presentation that I delivered at the UNC Alternative Investments Conference last week (some of the slides are featured below). If you’re keen to see a 30-minute overview of EM PE, check it out on YouTube!

Alla prossima,
Mike

Abraaj: Part Deux

In last month’s newsletter we discussed the drama at Abraaj following revelations that four LPs had hired forensic accountants to probe the books of the Abraaj Growth Markets Health Fund.

The situation is serious, indeed:

  • Abraaj’s fund management business is being split off into a separate entity with an independent board “to which internal audit and compliance will directly report.”
  • Abraaj’s founder, Arif Naqvi, relinquished management of the funds business, though he is expected to serve on its investment committee.
  • The firm announced a halt to investment activities.
  • Private Equity News reports that Themis, the energy team that Abraaj acquired in March 2016, sought to end its partnership with the firm as early as mid-2017. Denham Capital announced a new platform agreement with Themis earlier this month.
  • The WSJ reports that the firm is weighing job cuts as its fundraising is put on hold; existing investors in its $6B target mega fund are asking for their money back; investors in other funds are considering selling their stakes; and, lenders are reviewing credit lines for their capital call facilities.
  • The FT reports that the firm’s CFO departed.

Meanwhile, the firm is still unable to secure an exit from K-Electric, a divestiture it announced in October 2016. Abraaj was slated to receive a consideration of $1.77B from Shanghai Electric Power, a subsidiary of the State Power Investment Corporation of China; however, the transaction has been dogged by delays.

According to a local news report dated 9 March, the Pakistani government still had not cleared the sale, in part because it has not received a copy of the sale-purchase agreement, in part on national security grounds, and in part because the company is alleged to owe “dues” upwards of PKR139 billion (~$1.25B). Arif Naqvi is reported to have met with government ministers this week in an attempt to accelerate the sale.

What a mess. I’m left wondering if investors in the firm’s funds will seek (a) new GP(s) to manage out the assets.

EM Fundraising: Coming Full Circle?

 

giphy2

“Coming Full Circle.” So reads the adulatory headline from EMPEA’s year-end 2017 statistics, which show $61 billion in EM fundraising across PE, private credit, and infrastructure and real assets—the highest level since 2008. Break out the champagne glasses and lace up those dancing shoes. EM PE is back!

Or not.

Looking at fundraising for buyout and growth equity funds, the volumes remain stagnant since 2011 (see below). Though 2017 shows a rebound, the aggregate figure is deceptive: KKR Asia III clocked in at $9.3B and Affinity Asia closed on $6B, which means these two funds account for 40% of the capital raised for buyout and growth strategies. That leaves about $20B for the rest of EM. It’s peanuts!

FRchartv2

The trends we highlighted in November 2016 are continuing apace, with only 75 growth equity funds achieving a close in 2017—a 44% decline since 2010. In addition, new entrants are struggling to get traction. EMPEA’s own analyses show that first-time growth equity funds have declined from 30% of the capital raised for the strategy in 2008-09 to less than 10% over the last four years.

At issue is a lack of distributions and a lost decade for LPs in EM buyout and growth equity funds (see below). There is a sharp drop-off in distributions beginning in 2007 / 08 when fundraising exploded. It’s a decade later, and the breakpoint for top-quartile funds beginning in 2008 hasn’t returned investors’ capital.

lostdecade

These performance indicators from Cambridge Associates are damning, and it’s no surprise why LPs have been walking away from “traditional” EM PE in greater numbers.

But there’s something about this exhibit that bothers me. I know many established managers that refuse to provide their performance figures to Cambridge. One global manager was befuddled when I presented these figures; s/he noted that their EM deals generated IRRs well north of 30%.

It’s worth asking whether Cambridge’s benchmarks are a worthy benchmark in EM. I have my doubts.

For example, a quick sketch comparing the universe of EM buyout and growth equity funds—as collected by EMPEA—to those in Cambridge Associates’ database show that CA has between 4% and 21% of the total number of funds by count, and between 29% and 60% by total capitalization (excluding 2011; see below).

cambridge

The industry is poorly served by these benchmarks. I should probably stop using them, but there is no credible alternative.

If only there were an organization that could serve as a utility for the industry—one that provided impartial data on private capital performance … 🤔

In any event, as bearish as I’ve been about the prospects for the EM PE industry, I am cautiously optimistic that we’re close to reaching a bottom. If flows to EM public equities continue, then the exit windows should stay open, managers should distribute cash to their LPs, and then capital can be recycled to new commitments.

While I don’t expect EM-dedicated growth equity and buyout funds to come “full circle” to the $58 billion they raised in 2007 anytime soon, the scarcity of capital allocated to the sub-$1 billion segment portends well for the performance of current vintages. And if history is any guide, LPs will herd back into these markets after the “easy” money has been made.

giphy1

Private Equity: Overvalued and Overrated?

Dan Rasmussen of Verdad is not making friends with many people in private equity. His former colleagues at Bain Capital must wish he’d stop talking. Like him or hate him, Dan puts out thought-provoking, empirically driven takes on the myths and realities of U.S. buyouts (see last December’s newsletter for an example).

In his latest piece, “Private Equity Overvalued and Overrated?”, Dan probes three premises about which there is “near-complete consensus:”

  • PE firms make money by creating value in portfolio companies;
  • PE is less volatile / risky than public equity; and,
  • PE will significantly outperform other investments.

Rasmussen’s most interesting conclusion pertains to the first bullet: the myth of value creation. Verdad constructed a database of 390 deals—representing more than $700 billion in enterprise value—for which the PE firm issued debt to finance the acquisition. This enabled Verdad to compare underlying companies’ financial performance both pre- and post-acquisition. What did they find?

In 54 percent of the transactions we examined, revenue growth slowed. In 45 percent, margins contracted. And in 55 percent, capex spending as a percentage of sales declined. Most private equity firms are cutting long-term investments, not increasing them, resulting in slower growth, not faster growth.

If PE firms are not growing businesses faster, investing more in growth, or gaining much operational efficiency, just what are they doing?

In 70 percent of cases, PE firms are leveraging up the businesses they buy. PE firms typically double the amount of debt on the balance sheet, from 2.5x EBITDA to 5x EBITDA—the biggest financial change apparent from our study.

With $1.7 trillion in dry powder, rising rates, and average U.S. LBO entry multiples hitting 11.2x EBITDA, this just does not seem like an attractive value proposition.

Persistence in Private Equity

McKinsey’s Global Private Markets Review has a fascinating finding on the decline of persistence in private equity performance. Notably, “follow-on performance is converging towards the 25 percent mark—that is, random distribution.”

At a time when capital is flooding to mega-cap funds and, at least in emerging markets, established GPs with a track record, I wonder whether new techniques are needed for manager selection. Perhaps the winning LPs will be those with the liberty to chase a variant perception of value; those less hamstrung by rigid asset allocation buckets and / or institutional constraints.

Je ne sais pas.

From the Bookshelf

A man is born gentle and weak.
At his death he is hard and stiff.
Green plants are tender and filled with sap.
At their death they are withered and dry.

Therefore the stiff and unbending is the disciple of death.
The gentle and yielding is the disciple of life.

Thus an army without flexibility never wins a battle.
A tree that is unbending is easily broken.

The hard and strong will fall.
The soft and weak will overcome.

— Lao Tsu, Tao Te Ching (Vintage: 1989).

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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.

Dumb Money

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:

LP Sentiment

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:

  1. “Dumb Money”!
  2. David Swensen’s recent remark that “the breadth of emerging markets that we were interested in 20 years ago has narrowed dramatically.”
  3. DFIs, which historically have supported the development of the industry, are increasingly committing to later, larger funds.
  4. The ongoing emergence of local, non-PE investors that don’t face the same return hurdles / horizons creates greater competition for quality deals.
  5. 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

The Great Wall of Capital

Fundraising for buyouts in Asia is robusto:

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.

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:

LAVCA.jpeg

  • 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)

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).

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

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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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.

 

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