Regional round-up

LPs outline the challenges and opportunities in their respective focus regions

The pandemic’s effect has been uneven across different emerging markets, with some faring better than others.

Here, LPs outline the challenges and opportunities they see in their respective focus regions.

Asia-Pacific and the Middle East

Interest in Asia among LPs continues to be strong relative to some other emerging markets, although the dominance of the Chinese market in the region perhaps masks more volatility elsewhere. China already accounts for the lion’s share of LP capital targeted at Asia-Pacific funds, a situation that looks set to continue.

From our perspective, global LP sentiment is positive for China.

- Edmond Ng, Managing Partner of Funds, Axiom Asia Private Capital

A recent Preqin survey found that, of all emerging markets, China was seen as offering the best opportunities in private equity during 2021, garnering 55% of responses. Southeast Asia came in second, with 37%, although it has fallen from top spot the year previously.

“China has elevated itself onto a different plane from other markets in the region,” says Tarun Luthra, Senior Investment Advisor at DEG. “That's in terms of its GDP per capita, absolute incremental annual GDP, foreign direct investment and the size of its equity markets.” And its COVID-19 response has only cemented its appeal for many investors.

“A year and a half into the pandemic, China has COVID largely under control and it is showing a strong V-shaped recovery,” says Manjia Guan, Senior Director, Head of Primaries, Asia, at Capital Dynamics. “It ended 2020 with GDP growth of 2.3% and is expected to deliver between 8% and 9% for 2021.

China’s economy is currently around 70% of US GDP and the gap is expected to close in the next ten years – that means a global economic power rebalancing could take place in one or two private equity fund cycles.”

LPs certainly seem bullish about the country. “We raised our most recent fund last year and it was the biggest we’ve ever closed,” says Edmond Ng, Managing Partner of Funds for Axiom Asia Private Capital, which has invested around half of its capital in China since it established in 2006. “From our perspective, global LP sentiment is positive for China.”

However, Ng suggests that the picture is not completely rosy. “The big cloud hanging over us is the US-China trade tension,” he says. “Some government pensions hesitated for a while, but they came in eventually – we’ll have to see how that plays out in the coming years.”

The region's second biggest emerging market - India - also continues to attract attention. “It's a US$2.5trn to US$3trn economy, much of which is unorganised,” explains Luthra. “It's a tale of two halves, where one half of the population resides in cities, in which about 100 million people have around US$15,000 on average per capita income, and the long tail behind that tapers off pretty quickly. When investing in India, it's important to be able to shape a strategy that traverses these two halves.”

The Indian private equity market has developed significantly over the past three or so years, adds Luthra. “We’ve seen the emergence of buy-outs as a big theme,” he says. “We’re excited about that, even as a development finance institution, because it enables the transition of very large businesses, stabilises shareholder bases, creates scaled large platforms from which to grow, and creates employment.”

Another key trend in the region is the emergence of closer ties between the Middle East and Asia. “We’re seeing more connections forged between East and West Asia (or the Middle East),” says Thomas Walenta, Senior Investment Officer, Asian Infrastructure Investment Bank. “The regions are becoming more integrated – there is strong interest from both pools of capital to invest. When we lend or do private equity deals, we’re working increasingly with both banks and institutional investors in East and Southeast Asia to fund deals in the Middle East.”

Overall, LP appetite for Asian investments appear largely undimmed as investors continue to seek exposure to the region. “We work with a lot of large institutional investors,” says Weichou Su, Partner and Head of Asia at StepStone Global. “At the beginning of 2020, we had thought, given the political tensions and COVID, we’d see a big shift downwards for Asia-targeted fundraising, but that hasn’t happened. Large institutions globally, but particularly in Europe and the Middle East, continue to believe that they need allocations and exposure to Asia and China, very often because of the talk of geopolitical issues and decoupling.”

We’re seeing more connections forged between East and West Asia (or the Middle East)

- Thomas Walenta, Senior Investment Officer, Asian Infrastructure Investment Bank

Latin America

Latin America’s private capital markets have had a volatile few years, although investors see some strong opportunities emerging. “The region came out of the Global Financial Crisis growing on the back of the commodities supercycle,” says Martijn Woudstra, Investment Officer at FMO. “We’re not seeing that tailwind this time around and the region seems to have been hit harder by COVID than other emerging markets.”

A recent poll of participants at the SuperReturn Emerging Markets event found that the biggest impediments to growth of private markets in the region was political risk, with 57% raising this, followed by currency risk with 29%. “Political risk is certainly an issue,” says Colin Curvey, Fund Head at IFC Asset Management Company, an IFC-owned GP that raises third-party capital. “But currency risk is a significant factor for dollar-based returns in private equity.”

These concerns, plus volatility and the devaluation of many currencies over the past decade, including that of the Brazilian real, has led to a situation in which many buy-out funds have struggled to raise capital. The GPs left in the market say this is creating an ideal situation for dealmaking, with low competition and strong dealflow.

“The development of private capital in the region has seen some big swings and shifts,” says Curvey. “While venture capital and private credit have grown tremendously, private equity has remained flat or declined. You also see a situation where around US$60bn has been invested by private capital in the last five years, but only US$30bn raised – what other region has that ratio? There are a couple of large firms that dominate fundraising, but very few focused on the region that can raise funds of US$1bn or more. At the same time, large LPs are getting larger and increasing allocations to private equity, but they need funds that are US$1bn or larger to absorb their capital. Perhaps it’s time to re-think the model for Latin America.”

Some investors may well start returning to Latin American private equity, however. Preqin’s latest investor survey on emerging markets found that 17% see the region as presenting the best opportunities – higher than both the Middle East and Africa. The drive towards impact investing could boost this, says Woudstra.

"Investors that have just started out their impact investment programme look for stable markets,” he says. “They see that less in Africa or even Asia, so there is appetite among these investors for Latin America. When we come out of the crisis and the currencies stabilise further, investors will feel more confident about the region again."

By contrast and in common with many other emerging markets, venture capital has had a strong few years in Latin America, with COVID disruption and the need to digitise playing strongly into this. Over the past few years the amount invested by venture capital funds has risen significantly, with more than US$4bn deployed in 2019 and 2020, double the US$2bn seen in 2018, according to LAVCA.

Perhaps it’s time to re-think the model for Latin America.

- Colin Curvey, Fund Head at IFC Asset Management Company

Africa

Africa-focused GPs, like many in other emerging markets, are no strangers to challenging conditions. So the pandemic’s arrival, its disruption and effect on fundraising, may well be viewed in hindsight as just another wrinkle to iron out by many of the continent’s seasoned GPs.

“With the exception of South Africa and North Africa, the continent was comparatively less impacted by COVID than the rest of the world,” says Arun Kumar, Principal Investment Officer at the African Development Bank Group. “Growth, however, has been delayed and we have seen a definite dip in valuations.”

This has had an inevitable effect on exits in some parts of the continent. “Some sizeable businesses with proven models have managed to attract trade or financial buyers, but there has been a delay in exits because of a decline in valuations, due diligence challenges and so on,” adds Kumar. The upshot of this, of course, is that LPs are now seeing a flurry of fund extension requests.

Among them is Marius Chirila, who covers private equity across emerging markets at the European Investment Bank, who says he is also now seeing requests to extend investment periods.

“In several instances, the investment pace has been slower,” he explains. “Some funds have made no investments at all over the past year because they have taken a cautious approach. It’s important to invest when valuations are attractive, but no-one knew when the bottom of the market had been reached – there was very little visibility over the full impact of the pandemic.”

And while Kumar notes an “all-time low for fundraising in the last 12 months”, Chirila says the situation has been somewhat better in North Africa.

“Fundraising activity in North Africa has fared better than in other African regions through the pandemic,” he says. “This is because several funds had already reached first close before COVID, so were able to attract more investors on the back of that momentum.”

The pandemic has accelerated digitalisation and that will optimise operations.

- Marius Chirila, Private Equity for Emerging Markets, European Investment Bank

This has been one of the main lessons for Chirila. “The importance of first closing sizes cannot be overstated,” he says. And for Kumar? “The past 12 months have been both interesting and challenging for private equity in Africa,” he says. “But the key lesson that we have learned is the importance of working together to build resilience and innovative businesses by integrating technology into portfolio companies. The pandemic has accelerated digitalisation and that will optimise operations.”

Central and Eastern Europe and Turkey

Central and Eastern Europe appears to have been relatively resilient to the pandemic, with a small rise in funds raised, from 22 funds closing with an aggregate US$2bn in 2019 to 24 totalling US$2.2bn in 2020, according to Preqin. This reflects the increasing scope of private capital in the region.

“We’ve seen more depth and breadth of private equity in Central and Eastern Europe over recent years,” says Anne Fossemalle, Director, Private Funds, European Bank for Reconstruction and Development. “Initially, we saw mainly growth funds, then buy-outs mezzanine developed and now we’re seeing the establishment of more infrastructure and private debt funds.”

José Cabrita, Head of CEE – Lower Mid-Market Investments at the European Investment Fund, agrees. “We’re starting to see a substantial surge in private equity and venture capital from both foreign and local or regional players, supported by European investors and the European Union funding.” He points to the different stages of the development in different countries, with Poland leading the way.

“Poland transitioned to a capitalist regime earlier than other CEE markets,” he says. “Czech Republic, Slovakia and Hungary followed and we’re seeing more private equity activity emerge there. The Balkans are coming up behind and the former Yugoslav countries are around 10 years behind in their transition, but they are starting to gain attention.”

However, fundraising does remain challenging. “It can take fund managers two to three years to raise the capital they need to be able to execute their strategy,” says Fossemalle. “The situation is even more difficult in Turkey because the economy is less stable and more uncertain. We see very established outfits with reasonable track records struggling to raise capital. The situation was challenging before the pandemic but has become more so since.”

Fossemalle is also concerned about a dearth of first-time funds currently. “We had anticipated that we’d see fewer first-time funds as COVID hit and our fears came to fruition,” she says. “It’s understandable because many people may not feel it’s the right time to change tack and raise a fund.”

However, investors in the region remain confident that the markets will continue to grow. “There are huge attractions in Central and Eastern Europe for LPs,” says Fossemalle. “There are plenty of established teams with good track records that include real exits. COVID is different, but these GPs have also weathered previous crises and so are used to disruption. LPs face less currency risk (with the exception of Turkey) as funds are denominated in euros or in currencies with strong ties to it.”

There is also a lot of excitement about digital transformation and some of the success stories that have come out of the region. Fossemalle points to businesses such as e-commerce group Allegro, which became the largest European IPO of the year when it listed in Warsaw in October 2020 and Romania’s UiPath, an automation software company, which listed on the New York Stock Exchange in 2021 and was one of the US’s largest software IPOs with a market valuation of nearly US$40bn.

And there is more to come, says Cabrita. “We can see a number of IT-related and digital companies set to come forward for IPO,” he says. “And it’s not just in IT services we see strong development. The digitalisation of many sectors – from banking and telecoms through to healthcare and consumer goods – is well underway in the region. All these sectors are very attractive for private capital.”