More private equity investors are delving into emerging markets, but significant hurdles remain to finding sustained outperformance, according to consultants and pension fund executives.
Unlike public equities, where the trend to invest overseas has resulted in sizable shifts into emerging markets, private equity strategies still are largely dominated by investments in developed countries, particularly the U.S. But more institutions are beginning to globalize their private equity portfolios, dedicating more capital to emerging and frontier markets.
The amount of money raised for emerging markets private equity strategies increased 64% to $39 billion in 2011 from 2010, although that's still below the pre-crisis level in 2008, when $66.5 billion was raised.
However, as a percentage of the total capital committed to private equity globally, emerging markets private equity accounted for 15% in 2011, up from 11% in 2008, according to the Emerging Markets Private Equity Association, Washington.
“Hunger for growth” is a large driver behind the interest in emerging markets private equity, said Miriam Schmitter, managing director and head of non-U.S. private equity research at Cambridge Associates LLC in London.
Among institutions that are looking to make new commitments to emerging markets private equity funds are the $235.2 billion California Public Employees' Retirement System, Sacramento; the 579 billion Danish krone ($103 billion) ATP, Hilleroed, Denmark; the $24 billion Texas Permanent School Fund, Austin; the $14 billion New Zealand Superannuation Fund, Auckland; and the $3.3 billion Fire & Police Pension Association of Colorado, Greenwood Village.
At ATP Private Equity Partners, the private equity fund-of-funds subsidiary of ATP with about e7 billion ($9.2 billion) in assets, emerging markets account for 10% of the target allocation for the latest fund launched in 2011, compared with 5% in the previous fundraising in 2007.
“In 2005, we decided that we needed to build our relations and understanding in emerging markets; otherwise, we might be left behind, as they were definitely gaining significance globally,” said Susanne Forsingdal, partner at ATP PEP based in New York.
Sovereign wealth funds have also become more aggressive investors in emerging markets private equity, said Alex Jones, senior analyst at Preqin, a London-based alternative investment research firm.
“Emerging markets are a big part (of the portfolio) for sovereign wealth funds looking at investing in private equity, not least because there are a significant number of such institutions based in (those) areas,” Mr. Jones added. In addition, SWFs “can be less risk-averse than other institutional investors in private equity because they are not worried by liabilities.”
While it's crucial for investors to have a meaningful allocation in emerging markets, “public markets are often very concentrated to handfuls of large companies that don't necessarily capture the potential of the local economy,” Ms. Schmitter added. Cambridge's own analysis revealed “little correlation” between gross domestic product growth and public equity market returns, she said.
A secondary reason for a higher emerging markets private equity allocation is diversification, said Tom Keck, chief investment officer at private equity consultant StepStone Group LLC, La Jolla, Calif.
“In addition, emerging market private equity is less efficient than developed market private equity,” Mr. Keck added. “There's essentially more alpha.”