Portico Advisers: Is Emerging Markets Private Equity Dying?

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<ul><li><p>Is Emerging Markets Private Equity Dying?Michael CaseyFounder &amp; Managing Director</p><p>November 2016 </p><p>porticoadvisers.com</p></li><li><p>Introduction</p><p>1 Is EM PE Dying? | | November 2016</p><p>Periodically o er e la e years, one a i question o ld burrow its way into my mind: is the e er i markets private equity industry (EM PE) dying?</p><p>Some of the data told a straightforward story: stagnant volumes of capital being raised by fewer and larger managers; a smaller number of funds achieving a final close. In other instances, a news story would cross my screen and leave me befuddled. IFC committed to CDH Fund V? The African Development Bank committed to Carlyle? I dont know the rationale for these decisions, and Im certainly not passing judgment on them. They did, however, spark a curiosity to examine EM PEs vital signs.</p><p>The prognosis that follows suggests that existential challenges are besetting the industry, despite its continued viability as an attractive asset class that can create value for investors and investee companies alike. I worry that fewer entrepreneurs will access the human and financial capital they need to grow, fewer people in emerging markets will find jobs, and we all will continue into the morass of secular stagnation.</p><p>I hope that you enjoy this piece, and that it kindles a search for solutions o e i d ry c alle e . o lea e drop us a line and let us know what you thinkwed love to hear from you.</p><p>Best wishes,</p><p>P.S. As Roger Leeds, founding Chairman of EMPEA and Professor at Johns Hopkins SAIS, notes </p><p>in his book on the asset class, a health warning is warranted on EM PE data. Caveat lector.</p><p>ContentsWhere are we in the industry life-cycle? | 2 |</p><p>Are new firms entering? | 9 |</p><p>Are stragglers leaving? | 17 |</p><p>Are there substitutes? | 20 |</p><p>Are legal and regulatory policies </p><p>supportive of industry growth? | 25 |</p><p>Where are we going? | 28 |</p><p>https://www.amazon.com/Private-Equity-Investing-Emerging-Markets/dp/1137435348/</p></li><li><p>Where are we inthe industry life-cycle?</p></li><li><p>The EM PE industry is not growingaFollowing rapid growth at the end of the last decadeand a swift recovery on the heels of the global financial crisisthe volume of capital raised annually has been stagnant since 2011</p><p>73 5</p><p>7</p><p>26</p><p>33</p><p>58 57</p><p>23</p><p>37</p><p>48</p><p>41 42</p><p>57</p><p>47</p><p>15</p><p>2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 1H 16</p><p>Total capital raised ($B)</p><p>Source: EMPEA, Portico Advisers3</p><p>106%CAGR</p><p>- 0.6%CAGR</p><p>Emerging Growing Shakeout Maturing Declining?</p><p>Chinas expansion, commodity supercycle, global search for yield</p><p>EMs take over as engine of global economy, easy </p><p>liquidity conditions</p><p>China slows, commodities hit, </p><p>liquidity cycle turns</p><p>Consolidation within the industry as number of zombie funds grows</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>A fundraising slowdown is visible across regionsOutside of Sub-Saharan Africa and the MENA region, PE fundraising hauls peaked in 2011 / 2012</p><p>0</p><p>5</p><p>10</p><p>15</p><p>20</p><p>25</p><p>30</p><p>35</p><p>Emerging Asia CEE &amp; CIS Latin America MENA Sub-Saharan</p><p>Africa</p><p>Multi-region</p><p>Private equity fundraising by region and strategy ($B), 2009-15</p><p>Source: EMPEA, Portico Advisers4 Is EM PE Dying? | | November 2016</p></li><li><p>Fewer private equity funds are achieving a closeaWhile an average of ~ 25 buyout funds achieve a close each year, there has been a 30% decline for growth equity funds since 2010</p><p>128</p><p>87</p><p>0</p><p>20</p><p>40</p><p>60</p><p>80</p><p>100</p><p>120</p><p>140</p><p>160</p><p>2009 2010 2011 2012 2013 2014 2015</p><p># o</p><p>f F</p><p>un</p><p>ds</p><p># of PE funds achieving a close by strategy</p><p>Buyout Growth</p><p>Source: EMPEA, Portico AdvisersNote: Excludes Venture Capital, Infrastructure &amp; Real Assets, and Private Credit funds5</p><p>&gt;30%decline</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>Capital is concentrating in fewer funds a </p><p>Fund vehicles $1 Billion in size are capturing a larger share of EM PE fundraising, while constituting only 7% of the total number of funds achieving a close in a given year (on average)</p><p>$6.2$12.9 $15.7</p><p>$16.3 $16.1</p><p>$29.6</p><p>$14.5</p><p>0%</p><p>10%</p><p>20%</p><p>30%</p><p>40%</p><p>50%</p><p>60%</p><p>70%</p><p>2009 2010 2011 2012 2013 2014 2015</p><p>% o</p><p>f To</p><p>tal P</p><p>E C</p><p>ap</p><p>ital R</p><p>ais</p><p>ed</p><p>% and volume of capital raised by PE funds $1B in size</p><p>Source: EMPEA, Portico Advisers6 Is EM PE Dying? | | November 2016</p></li><li><p> and in larger segmentsLeading to questions regarding a potential mismatch between capital flows and the landscape of investable companies in certain markets</p><p>0%</p><p>10%</p><p>20%</p><p>30%</p><p>40%</p><p>50%</p><p>60%</p><p>70%</p><p>80%</p><p>90%</p><p>100%</p><p>Emergi</p><p>ng Asia</p><p>Latin</p><p>Americ</p><p>a</p><p>Sub-</p><p>Saharan</p><p>Africa</p><p>Multi-</p><p>Region</p><p> CEE &amp;</p><p>CIS</p><p> MENA</p><p>Volume of capital raised by region and fund size, for vintage years 2012-16</p><p>$1B</p><p>$700m-$999m</p><p>$500m-$699m</p><p>$250m-$499m</p><p>$100m-$249m</p></li><li><p>8</p><p>A preemptive dispelling of criticism</p><p>Is EM PE Dying? | | November 2016</p><p>I received some gentle pushback on this issue of capital concentration when I wrote an article</p><p>about Sub-Saharan Africas private equity landscape two years ago. To be clear:</p><p> The problem is the thinning out of small-cap and mid-market funds, not the fundraisingsuccesses of larger funds. Many of the larger funds are managed by excellent firms,</p><p>and their ability to scale offers a potent demonstration effect.</p><p> The diminished number of small-cap and mid-market funds is a shame because thereare companies in need of expansion capital and business expertise, and theyre not</p><p>able to secure it. Moreover, it reduces future deal flow for larger funds.</p><p> The available data do suggest that the pools of investable companies at largersegments look relatively shallow, but that could be because there are, indeed, too few</p><p>companies in the formal sector; or simply because obtaining quality data remains an</p><p>onerous task.</p><p> The focus on investable companies misses the broader evolution underway, in whichfund managers are deploying capital into platforms and companies that do not yet</p><p>exist (more on this point later). In addition, it underplays the volume and tranches of</p><p>capital that some EM companies require to achieve scale.</p><p> Objectively, there is a non-zero risk that the concentration of capital in largersegments could lead to poor performance. But investors generally know the peer</p><p>groups of larger managers that are coming to market (often at the same time), and</p><p>they have placed their trust in these managers ability to execute their investment</p><p>strategies with discipline.</p><p>https://www.ft.com/content/b5ef2596-190f-3208-a738-6571591892f8</p></li><li><p>Are new firms entering?</p></li><li><p>Fewer first-time funds are achieving a final closeGrowth equity funds, in particular, are being pummeled as the private capital ecosystem is beginning to take the shape of a barbellmore VC and large-cap funds, leaving a thinned-out middle market</p><p>104</p><p>95</p><p>34</p><p>2526</p><p>19</p><p>24 18</p><p>13</p><p>8</p><p>714 13</p><p>12</p><p>9</p><p>13</p><p>2008 2009 2010 2011 2012 2013 2014</p><p># of first-time funds holding a final close by strategy</p><p>Venture Capital</p><p>Growth</p><p>Buyout</p><p>Source: EMPEA First-time Funds in Emerging Markets Brief, Portico AdvisersNote: Growth includes mezzanine funds10</p><p>- 10%CAGR</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>And theyre not getting help from DFIsDFIs are committing to more Funds IV+ than to Funds I, II or III, raising questions about GP viability, a DFI flight to quality, and the amounts of commercial capital that DFIs are catalyzing</p><p>0</p><p>10</p><p>20</p><p>30</p><p>40</p><p>50</p><p>08 09 10 11 12 13 14 15 16</p><p># o</p><p>f D</p><p>FI C</p><p>om</p><p>mit</p><p>men</p><p>ts</p><p>Fund I Fund IV+</p><p>Source: EMPEA, Preqin, Portico AdvisersNote: Includes 12 DFIs; fund # is based on the total number of funds that a firm has raised, </p><p>not simply sequential funds in a series; data through 1H 16 or latest available11</p><p>08 09 10 11 12 13 14 15 16</p><p>Vintage Year</p><p>Fund II Fund IV+</p><p>08 09 10 11 12 13 14 15 16</p><p>Fund III Fund IV+</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>0</p><p>1</p><p>2</p><p>3</p><p>4</p><p>1 10 100 1,000 10,000</p><p>Fu</p><p>nd</p><p> # </p><p>Fund size ($m)</p><p>log scale</p><p>DFI Commitments by fund #, size, and region, for vintage years 2006-16</p><p>CEE &amp; CIS</p><p>Emerging Asia</p><p>Latin America</p><p>MENA</p><p>Sub-Saharan Africa</p><p>Multi-region</p><p>Source: EMPEA, Preqin, Portico AdvisersNote: Includes 12 DFIs; fund # is based on the total number of funds that a firm has raised, </p><p>not simply sequential funds in a series; data through 1H 16 or latest available12</p><p>+</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>A lack of established GPs inhibits new commitments</p><p>0%</p><p>10%</p><p>20%</p><p>30%</p><p>40%</p><p>50%</p><p>60%</p><p>China India Southeast Asia CEE Brazil Latin America</p><p>(ex. Brazil)</p><p>MENA Sub-Saharan</p><p>Africa</p><p>% of LPs noting that a limited # of established GPs deters commitments to said market</p><p>2012</p><p>2013</p><p>2014</p><p>2015</p><p>2016</p><p>Source: EMPEA Global Limited Partners Surveys, Portico Advisers13 Is EM PE Dying? | | November 2016</p></li><li><p>Despite clear opportunities for alpha in early fundsThe dispersion of returns historically exhibited by earlier funds illustrates the precise opportunity for LPs to be in EM PEinefficiently priced assets, with clear benefits to astute manager selection</p><p>-20</p><p>-10</p><p>0</p><p>10</p><p>20</p><p>30</p><p>40</p><p>Fund I Fund II Fund III Fund IV Fund V &amp; Above</p><p>Net </p><p>IRR</p><p> (%)</p><p>EM PE fund net IRRs by fund #, for vintage years 2000-09</p><p>Source: EMPEA First-time Funds in Emerging Markets Brief, Cambridge Associates, Portico AdvisersNote: Net to LPs, as of 31 December 201414</p><p>Top 5%</p><p>Top Quartile</p><p>Breakpoints</p><p>Median</p><p>Lower Quartile</p><p>Bottom 5%</p><p>Is EM PE Dying? | | November 2016</p><p>How many gatekeepers / OCIOs recommended these funds?</p></li><li><p>14</p><p>11</p><p>7</p><p>31</p><p>23</p><p>19</p><p>Investing in a</p><p>first-time fund</p><p>First investment in a</p><p>seasoned fund</p><p>Re-up</p><p>Average # of days LPs spend on due diligence, by experience with fund and LP size</p><p>Small LPs</p><p>Large LPs</p><p>Source: The Importance of Size in Private Equity: Evidence from a Survey of Limited Partners, Marco Da Rin and Ludovic Phalippou 2016, Portico Advisers15 Is EM PE Dying? | | November 2016</p></li><li><p>Larger LPs Are deploying volume </p><p> Are culling their GP relationships </p><p> Are targeting established GPs with a demonstrated ability tooperate at scale </p><p> Are seeking GPs with a track record of returning capital withlow loss ratios</p><p>Smaller LPs Are right-sized for commitments to funds that can deliver alpha </p><p> But lack resources for manager selection </p><p> Or even ownership over the decision (i.e., use of gatekeepers orOCIOs) </p><p> And need access to moreand better qualityinformation on theasset class and the fund manager landscape</p><p>Source: Portico Advisers16 Is EM PE Dying? | | November 2016</p></li><li><p>Are stragglers leaving?</p></li><li><p>0.0x</p><p>0.2x</p><p>0.4x</p><p>0.6x</p><p>0.8x</p><p>1.0x</p><p>1.2x</p><p>1.4x</p><p>1.6x</p><p>1.8x</p><p>2004 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 2010</p><p>U.S. Private Equity EM Private Equity &amp; VC</p><p>DP</p><p>I M</p><p>ult</p><p>iple</p><p>Net distributions to paid-in capital multiple (DPI), by vintage year and quartile</p><p>Upper Quartile</p><p>Median</p><p>Lower Quartile</p><p>Source: Cambridge Associates, Portico AdvisersNote: Data as of 31 March 201618</p><p>U.S. Private Equity</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>137</p><p>176</p><p>Fund managers</p><p>achieving a close between 2005-09</p><p>Fund managers</p><p>raising a subsequent fund</p><p>EM PE fund managers achieving a close between 2005-09 that raised a subsequent fund</p><p>313</p><p>failed to raise a follow-on fund</p><p>Source: EMPEA, Portico AdvisersNote: Excludes Venture Capital, Infrastructure &amp; Real Assets, and Private Credit funds19 Is EM PE Dying? | | November 2016</p></li><li><p>Are there substitutes?</p></li><li><p>0</p><p>20</p><p>40</p><p>60</p><p>80</p><p>100</p><p>120</p><p>140</p><p>2009 2010 2011 2012 2013 2014 2015</p><p># o</p><p>f F</p><p>un</p><p>ds</p><p># of PE funds achieving a close by strategy</p><p>Buyout</p><p>Growth</p><p>Venture Capital</p><p>Private Credit</p><p>Source: EMPEA, Portico Advisers21 Is EM PE Dying? | | November 2016</p></li><li><p>4</p><p>8</p><p>10</p><p>8</p><p>10</p><p>2011 2012 2013 2014 2015</p><p># of impact investing EM PE funds closed</p><p>Source: EMPEA, Portico Advisers22</p><p>Who is an impact investor?</p><p> Global growth markets PE firm The Abraaj Group ispositioning itself as one</p><p> KKRs investment in Modern Dairy helped bring asafe supply of milk to millions of consumers</p><p> Pan-EM PE firm Actis helped its portfolio companyUmeme connect more than 120,000 Ugandans tothe countrys electrical grid</p><p> Impact firm LeapFrog invested alongside PE firmIndia Value Fund Advisors* in Magma Fincorp, aKKR portfolio company</p><p> Helios Investment Partners led a consortium ofinvestors to build out Africas telecom infrastructurewith Helios Towers Africa</p><p> (there are *countless* others)</p><p>* The investment was made by Indium V, an investment vehicle advised by India Value Fund</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>74%</p><p>49% 48%</p><p>Seek</p><p>co-invest</p><p>Invest in</p><p>first-time fund managers</p><p>Seek direct</p><p>investment opportunities</p><p>% of LPs indicating preferred means for accessing EM PE opportunities</p><p>Source: EMPEA 2016 Global Limited Partners Survey, Portico Advisers23 Is EM PE Dying? | | November 2016</p></li><li><p>Source: CDPQ, Thomson Reuters Zawya, Portico AdvisersNote: Platform company officially announced 9 September 2016, diagram for illustrative purposes only24</p><p>Investors</p><p>Corporate SponsorPE Sponsor</p><p>Platform Company</p><p> Targets controlling stakes in Indian power generation companies(conventional thermal, hydroelectric, and transmission assets)</p><p> Focuses on operating and near-operating assets with acquisitionsanticipated to take place over next two-to-three years</p><p> Initial capital injections of up to $850m, with option to upsize</p><p>Capital+</p><p>Expertise</p><p>Capital</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>Are legal and regulatory </p><p>policies supportiveof industry growth?</p></li><li><p>Source: OECD, Willis Towers Watson, The Commonwealth, MFW4A and EMPEA Pension Funds and Private Equity: Unlocking Africas Potential, Portico Advisers</p><p>26</p><p>North America &amp; Western Europe</p><p>&gt; $21T in pension assets, with regulatory complexity </p><p>being layered on</p><p>- AIFMD- FACTA- SEC- Solvency II- Volcker Rule- ESG- Brexit</p><p>Emerging Markets</p><p>&gt; $2T in pension assets, with </p><p>regulators generally keen to facilitate investment</p><p>- Enabling pension funds &amp; insurance cos to invest in PE</p><p>- Innovative structures for DC plans to pursue long-term investments</p><p>- State-supported PE &amp; VC ecosystems (i.e., China, Brazil)</p><p>Is EM PE Dying? | | November 2016</p></li><li><p>Beyond track record, what are you most concerned with?</p><p>0%</p><p>10%</p><p>20%</p><p>30%</p><p>40%</p><p>50%</p><p>60%</p><p>70%</p><p>2014 2015</p><p>Team stability</p><p>Proven operationalexcellence</p><p>Clear strategy</p><p>Reporting</p><p>Were you subject to a regulatory audit or examination in the past two years?</p><p>72%59%</p><p>53%</p><p>28%41%</p><p>47%</p><p>2013 2014 2015</p><p>Yes</p><p>No</p><p>Source: EY 2016 Global Private Equity Fund and Investor Survey, Portico Advisers27 Is EM PE Dying? | | November 2016</p></li><li><p>Where are we going?</p></li><li><p>Source: Portico Advisers29 Is EM PE Dying? | | November 201629</p><p>Traditional PE Funds</p><p> Standard fixed-life (i.e., 10-year), blind pool, closed-end fund</p><p> Likely to remain thepreferred vehicle forestablished GPs, large LPs,and DFIs</p><p>Platform Companies / Deal-by-Deal Funds</p><p> Allow firms to mobilizecapital for a singleopportunity</p><p> Reduces amount of timespent fundraising and canfoster strong relationshipswith investors</p><p>Evergreen /Listed Vehicles</p><p> Allow firms to raisepermanent capital</p><p> Likely to grow in popularityfor asset managers offeringmultiple strategies (e.g.,equity, mezzanine, credit)</p><p>Pledge Funds</p><p> Enable firms to build atrack record while givinginvestors the option topass on deals</p><p>Hybrid Funds</p><p> Provide flexibility to pursueopportunities across publicand private markets (e.g.,hedge funds employingside pockets for illiquidinvestments, PE firmsexecuting PIPEs)</p><p>Corporate Partnerships / Joint Ventures</p><p> Team with multinationals tode-risk acquisitions /validate entry in newmarkets</p></li><li><p>1</p><p>4 4</p><p>5</p><p>6</p><p>7</p><p>13</p><p>6</p><p>15</p><p>9</p><p>0</p><p>2</p><p>4</p><p>6</p><p>8</p><p>10</p><p>12</p><p>14</p><p>16</p><p>$0.0</p><p>$0.5</p><p>$1.0</p><p>$1.5</p><p>$2.0</p><p>$2.5</p><p>2006 2007 2008 2009 2010 2011 2012 2013 2014 2015</p><p>Private capital fundraising ($B, #)</p><p>Capital raised via LP-GP structures Capita...</p></li></ul>

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