Emerging markets drawing big capital

Emerging markets private equity is on a roll.

The level of private equity fund-raising targeting emerging markets is at record levels with further growth expected to be sustained over the long run, according to consultants, managers and pension fund executives.

In 2007, private equity fundraising dedicated to emerging markets nearly doubled to a record $59 billion globally compared with $33 billion the previous year, according to data from the Emerging Markets Private Equity Association, Washington. The industry organization represents 195 managers in 74 countries with $700 billion in total assets under management.

Despite the credit crunch, which is causing acquisitions in the U.S. and other established markets to dry up, private equity capital continues to be deployed at a healthy pace in emerging markets, managers said. In general, M&A transactions in emerging market economies depend less on leverage, they said.

Furthermore, asset managers and pension fund executives bracing for an economic slowdown in the U.S. and Western Europe might be looking toward less mature markets in Europe and Asia to diversify their sources of returns, said Christopher Rowlands, managing partner of Asia for 3i Group PLC based in Singapore. In April, 3i raised $1.2 billion for an India infrastructure private equity fund. The amount was 20% above the target.

“Emerging markets is our principal strategic objective for a number of reasons — portfolio diversification and excellent growth prospects being among them,” Mr. Rowlands said. “The fundamentals look strong, not withstanding current market turbulence.”

Recent volatility in emerging markets might actually help private equity managers by pushing companies to seek private equity funding and potentially lowering valuations, managers said. In addition, emerging market economies have also largely escaped the subprime crisis and resulting credit problems, leaving local financial institutions in a better position to finance small to medium-size deals.

As a consequence, private equity managers who have been building their presence in emerging markets over the past several years might find that they're now in a better position to weather the global economic downturn, consultants said.

“Private equity's job is that it has to invest; it has to put that money to work,” said Paul Schaye, managing director of New York-based Chestnut Hill Partners LLC, which helps private equity firms find investments. “If that means finding opportunities in the less mature markets, then that's what has to be done.”

However, consultants also warned that a lengthy credit crisis inevitably will damage returns for private equity managers globally, including those operating in emerging markets.

“I think strategic investors are still moving forward and looking on a case-by-case basis in regions that are less likely to be affected by the (credit) crisis ... emerging markets are viewed as being more insulated,” said Eric Johnson, managing director at Cambridge Associates LLC, Boston. “But if we have a prolonged crisis, that's not good for exit (strategies), which will hurt returns and eventually make fundraising more difficult.”

Most funds raised in 2007 occurred during the second half of the year, according to EMPEA.

Fund sizes reached record levels in 2007. TPG Asia V, a pan-Asia fund, raised $4.2 billion, while the KKR Asian Fund LP raised $4 billion. There were 19 funds that raised $1 billion or more compared with four in 2006. Average fund size increased to $426 million in 2007 compared with $272 million in 2006.

“Based on preliminary figures ... we don't expect a slowdown” in the first half of 2008, said Jennifer Choi, director of research for EMPEA.

The total raised for emerging markets funds still is only a fraction of the $324 billion raised for U.S. funds in 2007, according to data from London-based Private Equity Intelligence Ltd.

At 3i, Asia accounted for 10% of the firm's €11.7 billion ($18 billion) total assets under management as of Sept. 30. That's quintuple the proportion of assets invested in Asia three years ago. Overall, 16% of the group's total investments in 2007 were in emerging markets compared with “next to nothing” three years ago, Mr. Rowlands added.

RREEF Alternative Investments, the global alternative investment subsidiary of parent company Deutsche Bank AG, Frankfurt, plans to invest $1 billion in India within the next three years, mostly in real estate and infrastructure private equity. Earlier this year, RREEF bought an undisclosed stake in Golden Gate Properties Ltd., an unlisted developer in India. Emerging markets private equity investments have been dominated by certain sectors, such as infrastructure and real estate.

“Private equity's role in the development of (emerging markets) property and infrastructure is, in some ways, more relevant today than it was six to 12 months ago,” said Kurt Roeloffs, Singapore-based chief executive officer of RREEF Asia Pacific, which doubled assets under management to about $15 billion at the end of 2007 compared with two years earlier.

“Asia has become a key investment destination for (private equity) investors all over the world,” Mr. Roeloffs said. “They do believe in the diversification benefits. Overall return opportunities are greater and growth prospects are greater.”

The $248.2 billion California Public Employees’ Retirement System, Sacramento, has an estimated $2 billion committed to emerging markets private equity. “These are rapidly growing economies that offer us enhanced diversification with maturing private equity markets,” Clark McKinley, spokesman for the fund, said in an e-mail response to questions. “We anticipate higher risk but also greater potential returns.”

The 440 billion Danish kroner ($91 billion) ATP pension plan, Hilleroed, Denmark, also is among those expanding into emerging markets private equity. Susanne Forsingdal, partner at ATP Private Equity Partners, which manages the fund's €6 billion ($9 billion) private equity portfolio, said the move will likely be made later this year or early next year. Ms. Forsingdal declined to detail how much will be committed or in what region.

“We're looking at India, South Africa and Australia, which from a private equity standpoint is considered an emerging market,” Ms. Forsingdal said. Last fall, ATP made its first emerging market private equity investment in Mid Europa Fund III LP, an opportunistic fund targeting Eastern Europe. She declined to specify the amount.

Besides normal emerging market risks — political, regulatory, cultural, managerial and currency factors — investors also must contend with the lack of long-term track records, Ms. Forsingdal added.

Another concern with emerging markets private equity is whether the record levels of capital raised can be deployed efficiently.

“We haven't seen many big buyout transactions,” said Richard Frank, CEO of Darby Overseas Investments Ltd., Washington, which has $2.2 billion in emerging markets private equity assets under management at the year-end 2007. “As much larger pools of capital become available, the big question is what will be the pace of big transactions. At the moment, they're (transactions) still proving difficult to do.”

The Carlyle Group, Washington, launched its Middle East operations in 2006 and has yet to make a single investment, even though it expects to raise about $750 million.

“We make investments when they make sense,” said Christopher W. Ullman, spokesman for Carlyle. “When I joined in 2001, the real estate team went through a year and half without making an investment. Then in the following two years, (the team) deployed all the capital. Things ebb and flow.”

Contact Thao Hua at [email protected]