The most-read guest commentary of the year was written by PineBridge’s Valerie Chen, Cristina Alcaide and Amit Mahajan, and published on 27 May. The trio discussed a new wave of supply in emerging market secondaries and the reasons why buyers with local expertise are best placed to exploit these opportunities.
Secondary transactions involving emerging markets assets are attracting increasing attention from investors, due to the anticipated rise in secondary supply and the potential to acquire assets at attractive prices by exploiting market inefficiencies.
Traditionally, developed markets have comprised more than 90% of total capital raised, funded mainly by limited partners in the same region, according to the Emerging Markets Private Equity Association.
As the private equity markets in North America and Europe mature, investors have turned their attention to emerging markets in the search of superior returns. The amount of money raised for emerging markets has more than doubled since 2007, which we expect to lead to a significant increase in emerging market secondaries.
Source: PineBridge Investments
Emerging market secondaries is still in its infancy and comprises only 5 to 10 percent of the global deal flow, according to UBS. Going forward, PineBridge Investments expects emerging market secondaries to take 10 to 15 percent of the global deal flow, as from 2013 onwards we continue to see a significant increase in deal flow.
LPs in developed markets have been the main sellers of private equity, using the secondary market as a portfolio management tool. At the same time, local institutional investors in emerging markets are building exposure to private equity.
We believe we are now at the point where the portfolio of many LPs in emerging markets has started to mature, bringing with it the potential of a new wave of secondary supply.
Why do emerging markets offer an attractive alternative to their developed market counterparts?
Public markets in emerging markets have higher volatility, compared to their counterparts in developed markets, and investors have to contend with headline and currency risk, leading to short- to medium-term dislocations. However, the current economic cycle in emerging markets has the potential to lead to a better pricing environment which presents an excellent entry point for secondary buyers.
Despite the slowdown in growth, 2014 and 2015 forecasted GDP growth for emerging markets is 5.1 percent and 5.4 percent, respectively, compared to 2.2 percent and 2.3 percent for developed markets, according to the International Monetary Fund. We believe that, given healthier balance sheets and the diversity among emerging markets regions, these markets still offer better growth opportunities – in other words NAV appreciation – than developed markets.
Local knowledge can lead to successful investing in emerging market secondaries
The lack of transparency and financial liquidity are common themes in emerging markets, with each specific country having its own risk profile. Without deep local understanding of the risks involved, it is very difficult to conduct due diligence and determine a fair price for a secondary purchase, which may lead to an unprofitable investment.
Furthermore, the quality of general partners in emerging markets funds varies. They often have short track records, and some have high team turnover, and therefore, the risk associated with emerging markets GPs is significantly higher than in developed markets.
Thus, only those who with deep knowledge about private equity in emerging markets are capable of underwriting and executing emerging market secondaries, by properly addressing both the growth potential and the risks. Such capabilities can only be found in committed investors in emerging markets with a longstanding local presence.
Preferred buyer features
GPs in emerging markets are growing and eager to increase their relationships with investors, showing a preference for investors with a long-term commitment to the region. Thus, we think that committed investors, like PineBridge, with a long-term local presence are in the strongest position to execute transactions.
In summary, the maturity of emerging markets private equity, in conjunction with NAV build-up, the current stage of the economic cycle, and an acceptance of the secondary markets by local investors should drive emerging market secondaries in the future. Secondary buyers with local expertise, who are able to ‘look under the hood’ and understand the embedded risks, will be best positioned to take advantage of the opportunity.
Cristina Alcaide is vice-president, secondaries of PineBridge Investments, London. Valerie Chen is vice-president, secondaries of PineBridge Investments, Hong Kong. Amit Mahajan is director, secondaries of PineBridge Investments, New York.