Is Asia blinding PE investors to other EMs’ potential?
Asia is dominating the thinking of private equity investors in emerging markets this year, as it has since at least 2016, but some industry experts argue that regions such as sub-Saharan Africa and Central/Eastern Europe (CEE) should be getting more play.
Private capital fundraising and investment in emerging Asia hit $50 billion and $38 billion, respectively, last year, according to the Emerging Markets Private Equity Association – the highest levels since the start of EMPEA’s research programme in 2006.
And Southeast Asia, India and China were seen as the three most popular EMs for investment by general partners over the next 12 months, according to EMPEA’s Global Limited Partners Survey published on May 7.
LPs – that is, investors into private equity funds – said they would need a far higher return premium over developed markets to justify investing in regions or markets such as Russia, Turkey and sub-Saharan Africa (764, 687 and 678 basis points, respectively) than they do for China, India or Southeast Asia (see figure 1). Even CEE would have to provide a substantially higher return premium than India or SE Asia, they said in the survey (545bp compared to 463bp).
Moreover, return expectations for SE Asia are higher than for most other EMs, according to the EMPEA survey (see figure 2).
But some private equity specialists suggested that some regions, such as CEE and sub-Saharan Africa, are being unfairly overlooked as a result.
Mark Florman, chief executive of Time Partners, a London-based merchant banking business focused on private equity and venture capital, said during a webinar this month: “I have always followed sub-Sarahan Africa, and I think it is intrinsically undervalued because of the perception of enormous political risk. But some of that is based on misunderstanding and the media.”
What's more, "the desired return premium for Central And Eastern Europe is far too high", said Florman. "Yes, there might be some risk [that might come from Russian president Vladimir Putin's actions], but 545bp seems too much for me."
By contrast, he would want a much higher return premium than 463bp from investments into India, given the high complexity of accessing them.
Meanwhile, Turkey is an attractive market, but it’s a classic example where political risk has overwhelmed some of the great managers, noted Florman. “Every LP looking at Turkey would probably like to invest there but cannot understand the twists and turns at the top of the country.”
A key issue facing certain markets, such as Russia and Turkey, is that investors are making a moral judgement on the actions of their governments, said the head of investment management for emerging markets at a London-based private equity firm.
“We have to accept that there is a moral perspective that people are taking on certain countries,” he noted, asking not to be named. “Russia and Turkey in particular are causing investment committees to hold their breath. Irrespective of how good the investment opportunities are in those countries, there is a moral hazard response that holds investors back.”
VC WORRIES
Separately, the soaring interest in venture capital (VC) is continuing to spark worries.
Around half (52%) of respondents to the EMPEA survey plan to start or expand investing in the asset class over the next two years (see figure 3 below). That’s a higher number than for any other PE asset class, and is up from 29% in the poll two years ago.
This high demand for VC investments – which tends to be focused heavily on technology and innovation – has led to huge competition among managers looking to start funds, rich valuations and widespread concerns that the sector is overheating.
Florman, whose firm has venture investments, said he has concerns about the level of enthusiasm for VC, as he has been through a number of market cycles.
“I think there is too much optimism [around venture deals] rather than [that they are] necessarily overpriced,” he noted. “[Investors] underestimate the challenges of building really successful venture businesses and how few succeed to create those extraordinary returns.
“People look at the success of Google, Facebook, Amazon and the fact that the technology sector has has a very successful decade,” added Florman. “I fear that people are hoping they can replicate the success we’ve seen in America in particular.”