Private equity firms are increasingly looking beyond emerging markets. But are they ready for the long haul?
For Western investors looking to venture outside their domestic market, the emerging world is not what it used to be. After more than two decades of dazzling growth, Brazil, Russia, India and China are slowing down. The Brics have also become more expensive places to run a business, with wages and other costs continuously on the rise. And their stock markets are on a losing streak: the MSCI Emerging Markets index has slumped 19 per cent over the past 12 months.
Time to look further afield? Mark Mobius thinks so. According to the chairman of Templeton Emerging Market Group, the future is now in ‘frontier’ markets – a subset of emerging economies, such as Nigeria, Kenya or Vietnam, with lower market capitalisation and liquidity levels. Their advantages are clear: strong GDP growth, large and young workforces, expanding manufacturing bases, and vast natural resources endowments. They also offer a low correlation to Western markets, at a time when the world’s biggest economies are increasingly moving in synch.
Buy-out firms look especially well placed to spearhead the new gold rush. Because frontier stocks remain highly illiquid, private equity groups allow their investors to attain better exposure to these booming economies than public equity markets. Their long-term horizon better suits that of developing nations, whose potential will take years to unlock. By pioneering their way into unexplored territories, they can uncover opportunities overlooked by most analysts. And fierce, local competition for access to capital means they can generally secure lowered valuations for their acquisitions.
Some are taking their chances with roaring enthusiasm. Leopard Capital, a fund headquartered in the Cayman Islands, has already lined up numerous deals in Cambodia, Laos, Hong-Kong and Bangladesh. London-based Cube Capital just launched the Cube Asia Frontier Fund, which will invest in real estate in frontier Asian markets. Both are among the handful of investors that have already dedicated $500m to Myanmar alone. Douglas Clayton, managing partner at Leopard, now wants to persuade Western funds to take a look at a ‘real’ frontier – Nepal and Bhutan.
His success is hardly a done deal. Lack of transparency, liquidity constraints, foreign exchange instability, and volatile political and social environments are all risks inherent to frontier-market investing. Mitigating them requires firms to move closer to their new ventures, as well as devote significant resources to developing on-the-ground expertise and local networks – something Western funds may be reluctant to do in the current climate. As says David Stevenson, author of the FT’s Adventurous Investor section: ‘Why would they take such a risk when they can pick up cheap, European mega-caps at bargain prices?’
Still, the trend is unlikely to fade away. With clear skies ahead for most frontier economies, and clouds still hanging over the rest of the world, it is probably a matter of time before frontier investing gears up for take-off.