Data & Intelligence

Alternative Paths to Liquidity

Unlocking “Stuck” Capital

Over the course of the past 15 years, emerging markets (EM) private equity (PE) has grown into a well-established segment of the global marketplace. From 2001 to 2008, capital raised annually for EM-focused private capital funds climbed from US$6.6 billion to nearly US$65 billion, and annual fundraising for emerging markets has totaled US$44 billion or greater since 2011, averaging 14% of the global total over the last six years.

Yet the rapid development of the industry, particularly in the years before the Global Financial Crisis, has not come without significant growing pains. Perhaps the greatest, and one of paramount importance for limited partners in EM PE funds, is lagging exit activity. According to market observers and participants, due to a number of challenges—ranging from macroeconomic and political turns of events to general overexuberance and a lack of consideration for exit when putting capital to work on the part of some GPs—many investors in those vintages have yet to see capital returned in sufficient quantity to consider their experience in emerging markets a resounding success.

Resolving the challenge posed by locked-up commitments is vital to the future growth of the industry in emerging markets. Without an increase in distributions to investors, many emerging markets-focused private equity firms will find themselves unable to attain re-ups for new fund offerings. Moreover, the industry as a whole will face increasingly difficult questions regarding its track record of success and the ultimate viability of the PE model in geographies where it has only recently put down roots. LP sentiment on this front is clear: over half of the investors responding to EMPEA’s 2017 Global Limited Partners Survey consider the lack of distributions from EM PE funds a top concern in managing their portfolios.

In order to help uncover a sustainable path forward, this Brief will explore EM PE’s track record for distributions over the last decade, why some fund managers have struggled to find exits in the past and, finally, how secondary transactions may provide an alternate path to exit for fund managers who have traditionally looked to strategic buyers and public markets to return capital to their investors.

A Look Back at the Boom Years

Fundraising for private investment opportunities in emerging markets grew precipitously in the lead up to the Global Financial Crisis, and as with any asset class that experiences a rapid influx of capital, changes in market conditions left many investors facing a sobering reality.

Stranded Assets

On one hand, many bets made during the boom years have not paid off. A sizeable fraction of firms that raised EM-focused vehicles around the time of the Global Financial Crisis have been unable to raise follow-on offerings and instead hold pools of legacy assets without a clear path to exit for investors. From 2006 through 2010, encompassing the pre-crisis and recovery years, US$48 billion was raised for emerging markets by firms that have since failed to launch a follow-on EM fund—representing 22% of total fundraising during this period. During 2008 alone, nearly US$18 billion was raised by firms that have not launched followon funds (see Exhibit 1).

Funds focused on Emerging Asia accounted for 52% of the 2006- 2010 total, with China alone constituting 25% of this stranded capital, perhaps to be expected given the deeper fund pool in Emerging Asia than in other emerging markets (see Exhibit 2). However, the region that appears most disproportionately affected by the phenomenon is CEE and CIS. The region accounted for 17% of capital raised from 2006 to 2010 by firms that have since failed to raise a follow-on fund, while the region accounted for just 11% of total EM fundraising over the same period.

Not all of the firms in question are the dreaded “zombies” featured in the financial media, nominally active and collecting fees even though prospects for underlying assets are bleak. Many have changed strategies or been acquired, but the numbers begin to hint at the extent of the problem. According to Ryan Wagner, Investment Director at U.K. development finance institution CDC Group, many PE investors who have decade-plus experience investing in emerging markets, especially in Emerging Asia, are familiar with the phenomenon: “Similar to other long-time investors, we have typical tail-end situations, many of which were raised in the pre-crisis first wave when it was easier for managers to raise money. Some of these managers didn’t have the ability to create value and really drive exits; in other cases, management teams have been ineffective or fallen apart. In several situations, assets are impaired, the fund is in liquidation or the manager could not raise a subsequent fund and only a subset of the management team remains. In any case, there hasn’t been a real push from some of these managers to get exits.”

EMPEA has served as a useful reference platform for CDPQ by helping to define the eligible universe of fund managers in growth markets. Membership provides background data and a...

Rashad Kaldany | Executive Vice-President and Growth Markets, CDPQ

The developed markets have no equivalent to the role EMPEA is playing as a convener and source of trusted information in the emerging markets.

David Rubenstein | Co-Founder and Managing Director, The Carlyle Group