LP interview: FMO

Like many development finance institutions (DFIs) in Europe and North America, Netherlands-based FMO wants to increase its exposure to Asia but is limited by capacity. While about 35% of the investor’s EUR10.4 billion ($11.7 billion) in assets under management (AUM) is in Asia, this is mostly managed remotely from the Hague. 

As a government-connected bank dedicated to a carefully quantified impact mandate, FMO must also dedicate a significant amount of manpower to regulatory and policy compliance. This leaves only 10% of the 600-strong team available for management of the private equity portfolio, even though the asset class represents 25% of total AUM. There are 15 investment professionals involved in Asia, each of whom manages 10-15 GP relationships. 

FMO knows there is risk in this tricky balance of resources and ambitions, but outsourcing due diligence in the region to third-party service providers is out of the question. The DFI was set up by the Dutch government to take on this challenge, and there is a sense in-house that any such partnering would represent a kind of self-denial. 

Meanwhile, the socially conscious nature of the firm’s vision statement – which focuses on financial inclusion, energy and agriculture impact – demands a certain level of internal quality control and adherence to a grounding strategic compass. So how does an DFI with these ideals and practical limitations get comfortable with young managers in Asia’s unproven markets?

“It’s learning by doing and getting it right sometimes and getting it wrong sometimes,” says Jorrit Dingemans (pictured), a manager focused on private equity at FMO. “The most important mitigant is taking your time in the courting period. I like to extend the due diligence process as much as possible to really get a sense of the stability of the team, the investment strategy, the track record, and the mandate.”

Strength in numbers?

Risk is further reduced in this process by relying on the collective due diligence capacities of FMO’s fellow DFIs, which typically face similar constraints in resources and Asian access. Where frontier jurisdictions are being targeted, it is not uncommon for three or four of FMO’s counterparts to jointly assess a given opportunity.

FMO has discovered, however, that hunting in a pack has risks all its own. This became especially clear in 2018 when The Abraaj Group achieved notoriety as the world’s largest insolvent developing markets GP on the back of allegations around misuse of funds and unpaid debt. In addition to FMO, the GP’s underlying investors included a host of DFIs known for restrictive diligence demands, including DEG, the IFC, CDC Group, and Proparco.

The episode has inspired FMO to pursue a managed account strategy, which has resulted in participation in two single-LP funds to date. AVCJ understands that one of these funds is in Asia, but the identity of the manager has yet to be disclosed since final terms are still being ironed out. The process has been delayed by the practical challenges related to COVID-19.

“We found that, as an LP, our means of intervening in fund management when things are not going in the right direction was relatively limited,” says Dingemans. “Where you are the only LP, you can actually control what’s happening. Every time the GP suggests an investment, you can test it on its own merits. It gives you a form of control over the build-up of the portfolio. So we’re actively trying to expand that approach.”

Control is a distinct theme despite a preference for LP commitments versus direct investments. About 65% of PE allocations are made to funds, with first-time ticket sizes around $15 million and second funds receiving up to $20 million. FMO targets relatively small funds to keep its stake between 5-20% and retain a seat on the advisory committee.

Geographic specialization is part of this thesis as well, with FMO backing funds dedicated to the Philippines, Indonesia, Sri Lanka, Bangladesh, Nepal, and Thailand. “Single-country funds tend to have local teams that are a lot better embedded in the local business community,” says Dingemans. “Regional funds flying in and out are not as equipped to create proprietary deal flow or hear the local gossip about M&A activity that could lead to better results.”

Big on Vietnam

Vietnam is the latest jurisdiction under the microscope. FMO already had exposure to the country when it decided in 2017-2018 that the time was right to double down, but the firm’s key partners – including Mekong Capital and PENM Partners – were fully deployed and not fundraising. With Vietnam expected to benefit from medium-term supply chain shakeups by multinationals in response to US-China trade tensions, as well as from accelerating digitization and policy liberalization, a new portfolio GP was needed to expedite the recommitment.

Last year, it backed the debut Vietnam fund of Excelsior Capital alongside Proparco and Switzerland’s SIFEM based on at least two key drawcards. First, Excelsior benefited from an existing Southeast Asia platform and a history of Korean fundraising, which provided comfort around governance. Second, the GP had built out a team with local savvy, including Chinh Xuan Hoang, who worked on the Mobile World investment at Mekong. The electronics retailer is the jewel of the Mekong portfolio, having generated an overall 57x return across multiple partial exits.

“When we see that a market is growing like Vietnam has been with so many businesses moving production capacity out of China, we want our managers to be in investment mode,” says Dingemans. “If all your funds are in divestment mode, you’re not creating development impact anymore, or at best, you’re creating limited impact.”

FMO quantifies impact by measuring jobs created, increases in taxes paid, and CO2 emissions saved by investee companies. It targets market returns, with IRRs of between 20-25% in each of its core areas. For energy and agriculture investments, including food and water, there is a tendency toward fund commitments due to the difficulties of managing the relevant assets without a local presence.

Co-investments are only made with groups that are already portfolio GPs. About 170 funds have been backed since inception in 1970. Current commitments represent exposure to about 2,000 companies. One of the strongest themes in recent years has been a drive into financial technology, which is seen as a nice fit for both the returns and impact agendas.

The strongest move on the fintech front in terms of fund commitments has been an LP position in the Accion Frontier Inclusion Fund, a global fintech joint venture between Quona Capital and emerging markets microfinance group Accion International. The program raised $141 million in 2017 for a strategy that includes a strong focus on India and Southeast Asia. FMO also participated in a $203 million follow-up fund raised earlier this year.

This relationship has facilitated some co-investment opportunities as well, with FMO joining Accion Venture Lab to co-lead a $7.2 million round for India’s FTCash, a mobile payments platform provider for micro-merchants. Two additional fintech-related fund commitment possibilities are currently being explored in Singapore. 

India has emerged as the most active arena for direct investments in fintech and financial services, and FMO has seen substantial success in this area. Standout exits include non-banking finance companies Ujjivan, MAS Financial Services, and Equitas, which filed for IPOs in 2016, 2017, and 2019, respectively. There is a sense, however, that the well might be starting to run dry.

“For a while now the financial sector in India has been facing challenges, especially non-banking financial institutions,” Dingemans says. “COVID-19 has not helped on top of that. Therefore we are currently very selective in making new direct investments in the financial sector in India.”

Recent direct investment activity outside India includes participation in two rounds across 2019 and 2020 for Validus, a Singapore-based financing platform for small to medium-sized enterprises in Southeast Asia. The plan is to support an operational expansion in Indonesia, which has been flagged as severely underserved in small business lending.

Careful calculus

A deepening footprint in politically complex Southeast Asia will test the reliability of FMO’s impact calculus, which tracks the flow of products and money across the economic linkages between the industries and countries where it invests. This model makes use of data from international statistical sources and investment-specific information, which FMO obtains from its partners’ annual accounts.

Using this approach, the DFI estimates that it supported 646,000 jobs in 2019, up from 615,000 the prior year. Its investments resulted in the avoidance of 868,000 tons of C02 equivalent greenhouse gas emissions, compared to 988,000 the prior year. Net profit from investment activities came to EUR120 million last year, down from EUR151 million in 2018.  

“Our direct investments have traditionally performed really well, while our funds have shown lower but steady and positive returns as well,” Dingemans says. “The main risk mitigant is diversification. In the current global crisis, we are about to find out how good that mitigant holds up.”

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• Topics
• LPs
• Europe
• Southeast Asia
• South Asia
• Fundraising
• FMO
• Vietnam
• India