As emerging economies’ need for investment becomes even more critical in the face of the pandemic, the International Finance Corporation is looking to undertake more direct investments, as well as co-invest with private equity fund managers, into emerging markets.
“We want to mobilise more people to invest into emerging markets,” Chew Huai Fong, IFC’s regional lead for its East Asia and the Pacific fund, told DealStreetAsia in an interview.
IFC, the private sector investment arm of the World Bank Group, is cognisant that investments into such higher-risk markets likely require backing from a development bank such as itself. And, as fundraising is expected to be more challenging in a COVID-19-impaired environment, support from development banks such as IFC is set to become even more important.
“There are some funds which probably won’t take off if they don’t have development bank money,” Chew says.
According to the OECD, external private finance inflows to developing economies could plunge by $700 billion in 2020, compared to 2019. This is 60% worse than in the immediate aftermath of the Global Financial Crisis in 2008 and impedes development progress that leaves countries even more vulnerable to future crises.
With its development mandate, IFC has been actively deploying into funds that are investing in emerging markets in Asia.
Recent activity includes a proposed commitment of $25 million in Navis Capital Partners’ $150-million fund dedicated to Cambodia, Laos, Myanmar, and Vietnam. The fund, which will be co-invested alongside Navis Capital’s eighth Asia fund and its parallel funds.
There are also direct investments in both equity and debt. For instance, a disclosure in November stated that IFC was considering a $10 million investment in the form of a one-year, renewable senior loan to Card Bank, a microlender in the Philippines.
IFC undertakes a thorough “scoring” of potential investments to ensure that the use of its funds is optimised. This includes examining the role that IFC can play, apart from providing funds.
“There are really not that many investors which will look at regions we look at,” Chew explains. “We give [potential investments] a score internally, as to what it reaches in terms of impact.”
“At the same time, though many people forget, we also look at it through a commercial lens. We are not charity, so we do need to make risk-adjusted returns.”
Edited excerpts of the interview:-
What is the impact scoring process on your potential investments?
Do we only contribute money? And if we only contribute funds, is it because there is a lack of funding or financing in this region? If so, then there’s a real need for our money in that case. Or do we contribute non-financially? Do we bring, for example, knowledge transfer, best practices; do we link up our funds with investees we have in other parts of the world? Do we provide them with gender best practices? The other part is about how the project itself can contribute to the ecosystem.
Are there specific conditions or mandates tied to such investments?
I don’t think we do that very often, because we want a manager to be able to execute a strategy well. So if you go and you tell them that you must meet all these conditions it could modify their strategy and they might not be able to execute and might not be able to be sustainable in the long run. At the same time, the other investors might not like it if it’s just IFC asking for all these conditions.
But of course, we do have some restrictions that we ask them to follow and they know that before they take our money. For instance, we have an exclusion list in our environment and social policy. And for us, 80% of our money needs to go to developing economies only. So we have small flexibility if they need to invest in something that’s headquartered elsewhere in a developed country. But we want most of our money to be really put to work in developing economies.
If you don’t tie your monies to conditions, how do you make sure your mandates are fulfilled?
We select funds which we think have a strong impact. It could be an impact in the form of the geographies they focus on – where [a few others] would want to invest so our money would make a huge difference. Or it could be the sectors that they target. For example, if they are in infrastructure or renewable energy – those already have some sort of impact. That’s the thesis that the manager brings to us, rather than us setting conditions on them.
Are you seeing more of such impact funds coming up and therefore offering more investment opportunities for IFC?
In the last two years or so, there are more impact funds – up and coming and also coming to us. I do see that the landscape is getting bigger and deeper. But a lot of that is just starting – a fund takes 10 years, so you can’t see the result until at the end of it. If these [funds] never had an impact in their theses at all, even in their previous [fund] lives, it’s difficult for us to tell how they will perform. Nobody knows, in the end, whether they can provide that return or reach the impact that they want, or they set out to do. I think it’d be difficult to assess right now, but there are more opportunities for sure coming to us.
All the funds that IFC invests in should have an impact, which is why we have the impact scoring system.
I definitely do see picking up over the years that IFC is able to mobilise other investors into like-minded funds for investing. The first thing we had to debunk was how people think that IFC is philanthropic. Of course, we do want to invest in sustainable businesses with good returns.
We collaborate very much with other development banks; not a lot of them have a presence in the markets that we invest in.
And besides the development banks, I would say in the last few years we see also family offices coming in. They value the IFC name because they have seen the funds that we invest in, and seen how they perform, seen us at work.
The reason we want to do more co-investments, besides the fact that there are opportunities, is also [because] we don’t want to crowd out private investors. The co-investment opportunities we are talking about is when there is a gap and IFC money is needed. And there’s also value in having it. It could be a direct endorsement of the company. It could be more robust systems that we put in place, in terms of governance.
What are the dynamics of investing in emerging markets in Southeast Asia and how do they differ from investing in more developed economies in Asia?
I think if you’re looking at growth private equity and if you are not a development finance institution, then it makes sense to diversify [allocations] because in Japan, Korea for instance, there are good funds established by majors players with stable pairs of hands, which will continue delivering those returns.
In Southeast Asia though, private equity is still very young. Even growth private equity is still very young. Big regional funds invest in Southeast Asia, but it is a very small portion of their overall global commitments.
For local Southeast Asia private equity [funds] – a lot of them are still very young, maybe [with only] a first and second fund. They haven’t shown many exits. For this private equity market to continue to deepen it needs a lot more proof of the thesis over the next few years.
At the same time, venture capital has caught up with the growth of private equity. VC in Southeast Asia is actually very vibrant and many more Western fund-of-funds or commercial investors are now looking at Southeast Asia for the VC piece if they already are overweight in China [for instance].
IFC’s investment in funds in East Asia is generally less than 20% of our global allocation. I think it will remain relatively stable, because of the mandate that we have. So we naturally want to put our money more where it matters more, in Africa for instance.
What is your view on investing in frontier markets such as Myanmar?
When it first opened up there was definitely a huge rush. We did see some funds set up shop to capitalise on the opportunities. It’s [a matter of] risk appetite. Higher risk means a higher return, but it could also be binary and you lose everything. I think people have gone in and experienced it.
We saw valuations being very high in Myanmar. Now it seems more muted and cautious than a few years back, at least from what we see in terms of the fund landscape.
From an LP’s perspective, what are the concerns you have when it comes to investing in GPs in Asia?
I think they need to improve on exits, understanding that they are not strategic investors, but they are private equity investors and that they have a fund life.
[The private equity industry in] Southeast Asia is still quite young. A lot of managers are on their second or third fund, for example. They are proud they’ve built a portfolio… they sometimes fall in love with the portfolio and remain invested, and they forget that the main thing is that they need to return the money to their LPs.
In Asia, a lot of the partners are local; they have a very good relationship with the founders of the business they’ve invested in. They are very close, which is great because you know more about the business, but you also have to make a very independent decision to exit.
We don’t see enough exits, basically, among Southeast Asia GPs. The DPI is not as high as I would have imagined. And that just proves that is a very young market.
How much pressure are GPs under, in the current environment, either to deploy or exit? What is your outlook for this year?
I don’t think in terms of new business, or exits, they will have that much pressure. I think most LPs are understanding because it’s our money, after all, we won’t want to sell at this time. And if they are slow on new business, I think most people understand as well.
But the pressure comes if you are fundraising. If you haven’t sold anything, then I think the pressure really starts.
I think what we will see in the next few months, and in the short term, is a little bit of the fear of missing out, because those funds which didn’t invest in the last few months are now looking very actively. But for the next year, I think it will still be a bit more muted. I don’t think the overall deal activity for 2021 will go back to 2018 or 2019. We will still be cautious.