In South-east Asia’s emerging markets, private equity (PE) remains a hot commodity with limited partner (LP) investors. The combination of attractive macro-level growth, inefficient financial markets and the intangibles of entrepreneurial talent have long fostered dreams of big PE returns across emerging Asia.
The fundamental appeal lies in the perceived opportunity to reap profits. Hence, it comes as no surprise that more than half of LP investors in a 2014 survey by the Emerging Markets Private Equity Association claimed that they will either be freshly allocating or expanding their funds in the South-east Asian region over the next two years.
Indeed, capital flows to PE funds in emerging markets have grown astronomically in the last decade and returns have been higher in host countries with unreliable market institutions.
That said, how PE works in advanced economies differs in emerging markets. Big, familiar PE firms such as Blackstone are generally more likely to do big and more familiar looking deals, while locally experienced and less well-known PE firms such as Actis and Abraaj Capital usually venture into smaller and more adventurous growth opportunities.
It is therefore not surprising that some of the bigger deals in Asia involve big, global names investing into companies initially identified by the more locally embedded country specialist investors. But are big international PE firms best positioned to seize on such opportunities in Asia?
The first couple of years of the normal eight to 10-year life of a PE fund are crucial to determining the success of PE funds in emerging Asia.
This is when the fund identifies, conducts due intelligence and negotiates terms for the best possible investments. These activities are more challenging in less-transparent economies, where formal government institutions are weak and market information is not readily available to everyone. Therefore, PE investors who have local origins or significant local track records, or ideally both, are substantially better equipped to overcome these challenges.
They are more capable at identifying and engaging with leading local entrepreneurs and business groups who have intimate knowledge to thrive better under local conditions. Such PE investors also know how to better manage these business relationships such that emerging-market “investees” are willing to share their winnings.
Yet, despite the critical role of local capabilities in the success of PE funds in emerging markets, it is a fact that foreign PE funds have played a leading role in the industry’s spread into new markets. Foreign PE firms often still outperform local PE firms in emerging markets, in large part because they have access to greater financial, talent and reputational resources.
Our research finds that reputation can become particularly valuable at the end of the investment cycle, when a PE firm is looking to exit an investment by selling it to a buyer on the global market.
If the global market has major concerns about the investment’s local institutional environment, a PE firm with a global track record and limited ties to the troublesome business norms of the local environment can greatly increase the confidence of potential buyers – that the “investee” company will be manageable.
This can have a significant effect on the willingness to pay.
Therefore, while companies in Asia can benefit from both local and foreign PE investors – depending on the availability of market information and how sophisticated the investment environment is – for larger and global PE firms having syndication arrangements may prove preferable to investing in localisation beyond mammoth markets such as China and India.