Asia – East Asia Pacific and South Asia together – accounts for the largest exposure in International Finance Corp’s funds portfolio. The private sector investment arm of the World Bank is focused on the development of the private equity asset class in emerging markets, and is actively seeking to encourage the creation of new fund managers, Ralph Keitel, principal investment officer and regional lead, East Asia and Pacific, private equity funds at IFC, said in an interaction.
He was also of the view that in Southeast Asia, it was difficult for new fund managers to get off the ground, when compared to China and India. “China is the second largest and second most developed private equity market in the world, that is starting to develop along the lines of a market like the U.S. You have well established groups and spinoffs from those groups – people leaving and setting up their own shops and buddying up with growth-hungry principals from other groups who feel they are not being promoted as fast as they would like. In China, in particular, and to some degree in India, we are seeing new fund formations on a very large scale,” he added.
According to him, when IFC seeks to become a limited partner (LP) in a private equity or venture capital fund, it looks to invest in vehicles that are addressing bottlenecks in areas such as education, healthcare, or agribusiness.
“…when we look at funds, there are a number of criteria we consider — the quality of the GP, the market environment and the developmental impact. One additional thing we do take into consideration is how many co-investments do we expect from that particular fund? Does the GP have a track record of doing deals that provide co-investments? For GPs and their investees, it is a beneficial proposition that we can provide both equity and debt. We also have an advisory services programme that strengthens the capacity and development impact of firms. GPs appreciate that, and we are looking for GPs that are looking for IFC as a co-investor, particularly in frontier markets and in strategic priority areas for IFC,” he added. Edited Excerpts.
You have invested in several VC and PE funds in this region. Has IFC increased its commitments to such vehicle of late, because you are often in the news?
That is the beautiful thing about IFC – everybody knows what we are doing. But let me add a word of caution – not all the filings we make translate into investments. In accordance with IFC’s public disclosure policy, any plans to make an investment are publicly disclosed. Some of your recent reports of us investing, for example, in Arbor Ventures’s new fund or Morgan Stanley’s North Haven Thai Private Equity – these are all ongoing investments and have not been finalized yet. There is always a chance that a fund might be oversubscribed when we make the announcement.
Asia (East Asia Pacific and South Asia together) accounts for the largest exposure in our funds portfolio. IFC invests exclusively in emerging markets and our portfolio is more focused on earlier emerging markets/frontier markets than other institutional investors. We are still actively investing in all emerging markets, whether it is China, India, or others. The beautiful thing about IFC is that we are a long-term investor and that our funding is in place. So, we have very stable allocations and can build long-term programs that do well over the long run.
When you evaluate a VC or a PE fund, what is it that you look for when you decide to become an LP in it?
IFC is a member of the World Bank Group and as a development finance institution (DFI), there is a developmental mandate in our investment strategy. Development impact is intrinsic to IFC’s mission and we remain committed to the World Bank Group’s twin goals of eradicating extreme poverty by 2030 and boosting shared prosperity. IFC’s funds group seeks to build a balanced portfolio of PE and VC funds. We are focused on the development of the private equity asset class in emerging markets and are actively seeking to encourage the creation of new fund managers. Of course, going back to how we allocate our assets, as a DFI, we are overweight on less developed markets and frontier markets. We are actively investing into what are considered bottlenecks in the emerging market space such as education, healthcare, or agribusiness. These are obviously key strategic priorities for IFC that we are seeking to address through our funds.
It is interesting that IFC is seeking to back new fund managers. Be it India, HK or Southeast Asia, while several new funds are being launched, how easy or difficult is it for a new vehicle in reality? Mostly, it is established fund managers from existing funds branching out on their own. We also have a scenario where many of the new vehicles have not been able to hit their targets for their first fund.
Obviously, we have to dig a bit deeper and look at the individual markets and see how developed they are. If we look at Southeast Asia, for example, I would say it is difficult for new fund managers to get off the ground. These PE markets are still quite nascent. I will give you an example – if you look at the PE market in Indonesia, it is a market of 250 million people. Right now, you have maybe four or five active PE funds there. Go back five or six years, and you have exactly the same number of PE firms in the market. It is not exactly the same in composition because some managers dropped out and some started anew – but the number really has not gone up. In such nascent markets, new fund managers are still facing huge difficulties in establishing themselves. And then if you go to the more frontier markets, Cambodia, Laos and such, there are even fewer managers.
This is very different from the more developed PE markets like China. China is the second largest and second most developed private equity market in the world, that is starting to develop along the lines of a market like the U.S. You have well established groups and spinoffs from those groups – people leaving and setting up their own shops and buddying up with growth-hungry principals from other groups who feel they are not being promoted as fast as they would like. In China, in particular, and to some degree in India, we are seeing new fund formations on a very large scale. There, depending on the sector they are in, the fundraising target, and how much backing they bring from existing investors, or from other high net worth individuals, or family offices they know, many of those new groups are remarkably successful in raising money. They may not all succeed, but the formation of new funds has really picked up over the last few years in India and China.
The second thing that you said was when you invest in a PE or VC fund, you look to see if they are able to address bottleneck in the ecosystem, and this often includes sectors such as education, healthcare, and agribusiness. Looking at the traditional and established PE and VC firms in the industry, how much leverage do you as an LP have to get them to invest in these non-sexy sectors? Most PEs and VCs want to do tech – they want companies that can become unicorns.
This is obviously part of our initial selection process. First of all, the sectors that are hot are also easy to get a little overcrowded, in terms of money supply. We don’t want to be going with the 49th or 50th VC fund or GP that is looking at the exact same space or market. What additional value do you, as a new fund manager, bring for investors? This is the first question we ask. What is your value-add in this space? Secondly, there is recognition. Sectors that might not be as sexy are underserved but may also offer a huge opportunity. Coming back to it, education and healthcare are sectors that IFC has always been actively promoting. Whether it is in the VC space or the Growth Equity space, some managers have done well, and that may well be because those sectors were less sexy in the past, and there was less competition for deals. More specifically, I think markets mature too and technology provides new opportunities compared to traditional brick-and-mortar education deals. There is now an active sector – edtech – and many VC groups are now recognizing the opportunity there with start-up companies doing well and providing new online education solutions specifically tailored for emerging markets. With mobile penetration rates rising, these kinds of investments offer huge opportunities, not just from a developmental perspective but also as an investment.
What is the status of IFC’s Emerging Asia Fund?
The Fund had its first closing in June of last year. Since then, there has been no further information that has been published. There is no official statement I can make with regards to ongoing fundraising efforts, unfortunately. I don’t have an update on the timing or the amount.
As an LP, when you see Asian vehicles, do you think a bulk of the money is going towards India and China? How do you see this region as a whole? Which markets do you think deserve the highest allocations?
I just need to preface that by saying that you are talking to an unusual fund investor. We are not like the typical U.S. pension fund or endowment that has fixed allocations for certain regions or countries. As described above, we are a developmental financial institution; our strategy is slightly different. We focus particularly on less developed markets, whether it is countries such as frontier markets, or sectors. But broadly speaking, if you ask me as a participant in the private equity space, there is a general focus on the rising middle class and the increase in consumer spending that comes with growing disposable incomes. This is the biggest theme in Asia, and this is the region with the highest GDP growth rates. Half of the ten fastest growing economies in the world are in Asia. Growth rates across Asia continue to be strong. You have positive demographic effects, young populations, and obviously, this is the big theme when I talk to LPs from developed markets.
You do investments independently. At the same time, does IFC also look at doing co-investments with the funds where you are an LP?
So again, IFC is very different from most other LPs. Many institutions sort of evolve by initially making passive fund investments, then they develop a larger programme. Once they reach a certain scale, such as some of the Canadian pension funds, for example – they will actively build out their direct investment programmes and do less and less passive fund commitments. The majority of what IFC does is direct investing, whereas investing in funds is a very small part of what we do; investing about $400-500 million per year globally to about 20-25 funds. So, IFC is first and foremost a direct investor and lender.
To answer your question directly, yes, when we look at funds, there are a number of criteria we consider — the quality of the GP, the market environment and the developmental impact. One additional thing we do take into consideration is how many co-investments do we expect from that particular fund? Does the GP have a track record of doing deals that provide co-investments? The benefit for the GP is that we are an active investor. IFC has almost 4,000 staff spread across more than 100 offices, including a number of investment officers and industry specialists who are actively investing in all these industries. We are a value-add investor that GPs seek out for the expertise and on-the-ground presence that we bring. For GPs and their investees, it is a beneficial proposition that we can provide both equity and debt. We also have an advisory services programme that strengthens the capacity and development impact of firms. GPs appreciate that, and we are looking for GPs that are looking for IFC as a co-investor, particularly in frontier markets and in strategic priority areas for IFC.
You do a lot of infrastructure projects. Just looking at Asia, especially Southeast Asia and India, the infrastructure funding gap is so massive. Where do you think the capital will come from? This is a big picture question and not specific to IFC. There is only so much that IFC and private equity can address in terms of the infrastructure funding gap in many of these countries.
There is a huge need for infrastructure investments, it is one of the biggest bottlenecks in the emerging market space, and it is something that IFC feels very passionate about. We launched a very interesting programme called the Managed Co-Lending Portfolio Program (MCPP) in 2013, that enables other investors to participate in IFC’s global portfolio. The program allocated $3 billion from the People’s Bank of China across 70 deals in less than two years. Based on the success of IFC’s MCPP program, IFC then launched MCPP Infrastructure, which seeks to raise $5 billion of private capital for investment in emerging market infrastructure loans by 2021. IFC recently signed an agreement with Eastspring Investments to raise $500 million for MCPP Infrastructure. The way IFC looks at this is that the public sector alone cannot finance this gap in infrastructure spending while on the other side there is a lot of money sitting on the sidelines – trillions of dollars – that asset managers and institutions are holding and which is generating very low returns. This money would be much better off being invested in the infrastructure space for emerging markets. So, a programme like MCPP is one way that we try to address this issue first through the private sector, and only if private investors’ return expectations cannot be met should they then be tackled by the public sector.
You said that there are trillions of dollars that can be put to use. Data shows that dry powder with PE and VC firms are at the highest. But how much of this do you see going into infrastructure? For most PE funds, infrastructure is not the core area they want to invest in.
I think this is a matter of strategic asset allocation. Private equity and infrastructure – most institutional investors consider them separate asset classes. I do not think many PE groups would consider investing in the infrastructure space given that growth equity is focused more on asset-light investment. With China’s One Road, One Belt initiative, much of the investments will be in core infrastructure like roads and ports in emerging markets. Of course, a lot of these investments will have positive trickle down effects that benefit broader economic development and thus create opportunities for private equity.
If we were to look at a lot of IFC deals in the region, they are often not the kind of deals that traditional PEs or VCs do. You lend to banks for projects that have social impact, and you also put in capital towards rural projects and microfinance, among others. Big picture — is IFC better positioned to do these kind of investments because you don’t have the traditional fund life and structure and you are not under pressure on exits?
As a development finance institution, we focus more on underserved sectors and markets. Emerging markets only became a separate asset class or even a term in the eighties – where a lot of money subsequently flowed to, some of which was driven by low interest rates in the developed markets. IFC went to the frontier markets long before it became fashionable. IFC has always been at the forefront of mobilizing private capital and it continues to be our mission to deploy capital where there isn’t yet an existing or well-functioning market. We are very conscious and careful not to displace the private sector or commercial capital but to invest where there isn’t a functioning market yet – whether it is in terms of geography, i.e. countries that do not yet have developed capital markets, where the banking sector is not developed or where there is insufficient funding for SMEs in particular. In many markets, banks prefer to lend to large conglomerates and family businesses. But for any lending to smaller SMEs, banks need 100% or more of collateral. Actively going into those countries and segments where there isn’t yet a functioning capital market to provide (equity) capital to SMEs is one of the key roles for IFC to play.
You have been observing Asia for the last couple of years – in terms of the LP-GP dynamic, what has changed?
I think in regards to the LP-GP relationship, it is a pendulum that continuously swings back and forth, depending on how much capital is available and how returns have been. At certain, bullish times, there is a bit of overshooting. GPs are less prone now as there is an understanding that this is a long-term asset class. If you lose your LPs because of more GP-friendly terms in good times, they will likely not come back down the road in more difficult times. So, there is a little bit of moderation that seems to be happening. The GP-LP relationship is a long-term game. It is really focused on governance. This is an issue that has been important to IFC. There is now a broader understanding that good governance is very important when you try to sell an asset to a strategic buyer five or ten years down the road. So there is a lot of positive momentum here.
In the US and Europe, corporates have been big players in M&A space. Ditto with family offices. This space has not evolved a lot in Asia, but it is now changing rapidly as we see Chinese corporates among the biggest deal makers, and we are also witnessing family offices in this region competing with PEs for deals.
Families dominate businesses in many parts of Asia, especially in markets like Indonesia and the Philippines. The larger families are conglomerates and are active investors – not just in real estate, which is what they have traditionally been doing for many years or decades. They are actively buying assets in neighbouring countries. The same is true for conglomerates and tech companies. In Southeast Asia, for example, you are seeing Chinese players like Alibaba, Tencent and JD.com actively doing deals. You look at ASEAN as a market block with 600 million people between India and China – this is a large market, and it presents a huge opportunity for investment in the consumer and tech space. We are just now seeing the beginning of that trend.
In terms of Exits, IPOs have been hard to come by in this region. China & HK are a different ball game. But for the rest of the region, IPOs are no longer the preferred exit route. Is that a concern?
I don’t think so. Outside of the most developed capital markets in the world like the U.S., IPOs have never been the number one exit option. Even in the U.S., it is not the preferred exit route. Anywhere in the developed or emerging markets, IPOs can never be the preferred target or exit route – it has always been M&As. I think that capital markets are evolving. In China, there is an active pipeline of Chinese companies that are listing. In all other markets, IPOs will always be a secondary route for exits. Once companies are able to grow and scale, they will prepare for an IPO knowing full well that in the process, they will also attract other buyers through the M&A route. Companies see an IPO as just one of the many options, and a trade sale is always the preferred one. Bottom line is that I think capital markets are evolving and there will be more IPOs. But the preferred route for exits is always a trade sale for PEs and VCs.
Big picture question not related to IFC — how do you see valuations in this region? Most GPs say that is the highest concern that they have.
Valuation is always a concern. I would agree there is a lot of dry powder available in this asset class. This is not specific to Asia, but a global phenomenon. It is a matter of supply and demand – larger pools of capital chasing a limited supply of deals, especially high–quality ones. This is bound to drive up prices. The way private equity funds are typically structured means that there is pressure to deploy capital raised. I would agree that prices in China and in Asia are not cheap. There is a lot of capital available in Asia – you have a lot of institutional private equity funds, both domestic and international ones. You have Asian families, conglomerates, and corporates who are all strategic buyers. Then there are a lot of financial buyers out there, including sovereign wealth funds, for example, here in Singapore, they are very large investors. So all of that provides a huge pool of capital available to be deployed and a lot of it is chasing the same number of high-quality deals. And that increases pricing, in particular when institutions have pressure to deploy.
Specifically talking about valuations in India, how big of a concern is that?
I would say if you look at the Indian market, prices, too, are not cheap. One could argue they didn’t adjust sufficiently after the global financial crisis. Public markets in India are not cheap – and a lot of private equity deals available are priced off of public markets. Our investment strategy for funds in India is very much in line with what we do in the rest of Asia and globally. We build a balanced portfolio and are generally sector-agnostic. Our strategy is to work with the best manager we can find.
There is nothing that differentiates the India from the Southeast Asia for you?
India is a very large emerging market by population. Its GDP per capita is lower than China, so it is a key focus market for IFC. We are very actively seeking to deploy capital in India and it is a key market for us, given the huge need for investment in infrastructure, health and education. Just addressing the basic needs for the population in India, such as reducing water scarcity, is one of the key priorities for IFC.
Just sticking to India. You mentioned some of the keys sectors you are interested in – education, infrastructure, agri-space. Again big picture, not specific to IFC, do you think there is enough investment from private equity and private investors going into these sectors? These are not popular with VCs and PEs.
We are actively trying to assess that gap. In response to your question, India is not very different from other markets. What you are seeing is that risk aversion among all institutional investors is increasing. What this means is that there is a flight to quality – meaning the large private equity groups are able to raise even larger funds at one end of the market, while it is very difficult at the lower end of the market to raise funds. In other words, there is a lot of capital if you look at private equity for large fund managers, while smaller SME funds are struggling to raise. Lots of people are trying to raise VC funds – not everyone will succeed. Some of those deals that are happening in Asia– Grab and Go-Jek, Alibaba buying Lazada etc. – these tech deals have a lighthouse effect. These deals are not only popular in Asia, but are being noticed on Wall Street and other places. There is a lot of interest in the tech space and a lot of that money is going to the early-stage consumer tech space in India. Not so much for later rounds.
What is the pain-point for Indian startups? Are Series B rounds and upwards when it comes to the $20-100m range too big for Indian VCs, and too small for PEs?
I would say that certainly from the Series C stage, there is a funding gap. Obviously, it is a young industry, but the proof of concept is not necessarily there yet for VCs to invest in this space. I don’t see much private equity money going into the VC space yet i.e., private equity investors doing late-stage tech rounds too.
To address this, are we seeing a trend where large PE funds, which often may not have the time and expertise to focus on a sector that interests them, and where deal sizes may not really move the needle for them, then create VC arms, or small vehicles with dedicated teams to look at these vertices? We have several such examples of this in India.
What you are seeing is not specific to India. It is more broad; it has been driven from the U.S. where traditional PE managers have branched out to become more broadly-focused asset managers, raising credit funds and real estate funds etc. Obviously, these kind of things do not go unnoticed in emerging markets. You are seeing that across Asia and China, in particular. Funds that were still focused on the middle market a few years ago are now billion-dollar funds. Now what they are doing is, there are quite a few firms that are now raising separate middle market funds again. You also have PE firms with dedicated VC arms – Northstar for example seeded NSI Ventures. What you are seeing is that traditional private equity groups are branching out and raising additional funds and strategizing different asset classes. But I don’t see a broader shift of private equity funds moving into the tech space. What you don’t have in Asia are dedicated tech private equity groups like Silver Lake and other funds in the U.S.
But we have a scenario where a Warburg invests in Go-Jek, which is not the traditional space that they play in. Is that not an interesting trend where firms are looking at opportunities in Asia that are not part of their traditional investment thesis in their core markets?
If you look at those deals, there is a broader trend, globally, of companies staying private longer. As the funding rounds get larger and go into hundreds of millions of dollars, these become too large for local players, let alone the tech funds. So you do need those investors if you look at the business model of a Go-Jek or Grab. There is a point where you are raising rounds – Series D, E, or F – where there is less of a technology risk than an implementation challenge – you are no longer just testing the market, but catering to the growing consumer and emerging middle class. This is very much in line with the strategy of those larger funds because this is the segment that they are after.
While these deals may be in line with the investment thesis of the large global funds, is it also not linked to the fact that most of these vehicles are now forced to refocus their attention on markets like Southeast Asia and India, because these regions offer far higher returns? Besides, China may not be the best place to be in right now.
Global investors and institutional investors that commit to markets like Southeast Asia and India are doing so based on the premise that they are expecting strong investments in such markets. I would not agree with the thesis that institutional and large global groups are investing in Southeast Asia because they have run out of deal flow or opportunities in developed markets such as the U.S. and Europe. What drives them to focus more on those markets is slightly different from emerging markets. In emerging markets, there are much less control deals, but more growth investing, and very little leverage. These institutions have committed to funds in Southeast Asia, India, or China out of conviction. They believe in the growth story, the rising middle class and the global rebalancing of GDP. They understand that emerging markets will play a larger role in the future composition of global GDP. That is the conviction they have, and that is why they back those funds. They don’t do it because they have run out of managers or good deal flow opportunities in the U.S.
Can it also be because, when you look at Asia, China and India, or Southeast Asia, the path to buyouts is becoming clearer? Promoters have become a lot more savvy – they are aware of PE and what private capital can do. Before the global financial crisis, we had seen private equity groups taking small stakes in companies here and not board positions. Do you think that has changed now – in this region, the path to buyouts becoming easier for private equity?
I think that is a normal part of the evolution of the PE asset class – you now have a larger share of the deals that are control deals. The share of deals that are control deals has nearly doubled in the past 10 years so yes, private equity is increasingly well understood across emerging markets and in Asia. But a lot of the low-hanging fruits have been picked and GPs need to step up their game, compared to the early 2000s where you could just ride top-line growth and bet on a multiple expansion. That sort of private equity doesn’t really work anymore. Sellers now are looking for GPs that can add value. They can deliver margins and improve or tweak the strategy, engage in M&A – things like that where GPs have demonstrated track record in adding value. This is what sellers are increasingly looking for. It is not necessarily the highest bidder that wins the deals, but the one who can convince the seller of his value proposition. I also do not necessarily agree with people who say that the best way to address the change in the market is to simply do more control deals – I don’t think that is the right means or solution to everything. If you are a truly value-adding investor, and you are perceived as such, you can do that even as a minority investor. I don’t necessarily agree that you have to buy a majority stake to be able to add value to a company. Good value-adding GPs can do that even if they have limited control.
Exits – how much of a concern do they continue to be, especially in markets like India?
Investing is not the most difficult part of private equity – it is getting the money out and giving it back to LPs. That is the difficult part. And from an LP’s perspective, it is all about getting your capital back and getting a good return on your money. LPs will always give preference to GPs that have generated good returns and can foster exits and give money to them. A lot of questions have been raised on PE deals in India that were done in 2005-2009 – a lot of these deals were done at very high valuations and then everything tanked. A lot of that money will not be returned. But I think there is a lot of positive sentiment around India and institutional investors now. Investors are taking a favourable look at India over its macro growth and the consumer story. When it comes to India, getting money back is at the top of mind for any investor, but the situation has improved. There have been a number of good exits over the past two years, and a lot of good money has flown back to LPs during this period. While investors are now more favourable towards India, they are still wary and LPs want to make sure that they back GPs that have a demonstrated track record of returning money.
One of the factors that worked for India was recycling of capital. A huge chunk of the capital from PE deals done before 2009 has now come back to the market and been recycled.
Good point. I think that for some of the deals, the money is yet to come back. Again, 2005 to 2009 vintages are all 10-12 years into the fund life – these funds have to be wound down one way or another. I remember looking at Asia a few years back and the sentiment around India was very negative then – it is much more positive now than it was even 3-4 years ago.
Has the investment climate in India seen a boost under the Modi-led government?
I think there is a lot of positive sentiment around India these days. The macro growth has been remarkable during the last couple of quarters, and there is positive sentiment around politics. The Modi-effect is still there. For PEs, getting some of their money back that had been stuck for a while is adding to the positive sentiment. I would say from a political standpoint, there is a positive sentiment that India is doing a lot of things right at the moment.
Are LPs and GPs bullish on India simply because other emerging markets have been performing a lot worse?
India is one of the preferred investment destinations among emerging markets now. The Emerging Markets PE association does an LP survey every year and this shows that the amount of capital that LPs are planning to commit in India has steadily risen for the past two years. It is in line with what I was saying earlier. Institutional investors are very favourable towards India now, and it is easy to understand why – the macro, top-line GDP growth has been very strong in the last year. It also has to do with portfolios – Asia is now well established as the third leg in global private equity after the U.S. and Europe. Most institutional investors are now present in Asia. Whether through a large global or regional fund, most LPs now have an Asian allocation. China has been around for a long time and has had an early solid performance in the 2000s. These funds have seen tremendous returns. Most LPs are now present in China. From there, it is a small step to come to the conclusion that India is the up and coming market with a very large population, and that it is likely to narrow the gap with China in the future. With a strong rising middle class and rising disposable incomes, it is very easy to buy into the premise that India is the next big thing to happen in Asia. Some LPs did get slightly burned by the bubble in the mid-2000s. But similar things have happened in other emerging markets, for example Brazil, but LPs recognize that ten years on, the markets have changed. They do see a lot of positive sentiment around India.