Limited Partner Q&A: International Finance Corporation

Q: Where does IFC's private equity thrust fit into the organization's bigger picture?

A: Seventy-five percent of IFC's business is lending; 25% is equity. And in that segment, we invest a little more than a fifth through funds. So it's a smallish part. But we're convinced that private equity, when it's done right with the right GPs, can really help developing companies get up to speed quickly, which creates not only more jobs, but better quality jobs.

We largely back first-time or emerging managers. Once they are successful and can attract sufficient commercial capital, we pull out and go find the next one.

Q: Typically, what size are your investments? And what about the returns?

A: It depends on the space the fund is in. At the small end you've got funds that focus on small business. The returns are likewise modest, maybe 8-10% net, which is clearly not something that commercial investors are going to pile into. These funds are quite small, say $30-50 million, and we might invest $5-10 million. We get involved with them because they can get us right out into post-conflict countries, the frontier of emerging markets.

Then there's the SME space, a totally different model. These funds are bigger, maybe $70-200 million, in which we may invest $10-20 million. With good execution, returns can be in the mid-to-high teens, say 15%.

Further up the chain are the mid-cap growth funds, which range from about $100 million to $500-700 million. In these we'd contribute $10-50 million. These funds are very attractive commercially, and likewise create a lot of jobs. The focal points are the larger end of SMEs (maybe 40% at the time of acquisition), with the rest being mid-caps.

Our experience is that these are very fast-growing companies, with top-line revenue growth of 20-70% p.a., and they get scaled to provide a decent exit. On, average they generate about 15,000 new jobs per fund, and we've earned 29% net IRR from them.

Q: How long have you been at this, and what impact has the GFC had on your efforts?

A: We started to back private equity funds from the early 1990s. But by 1999 it was obvious that we had a performance problem: i.e. the private equity segment was about one-eighth of IFC's balance sheet, with returns appreciably sub-par compared to IFC's direct investments. So we created a special department to deal with funds only, consolidating them from all over the organization, to clean up the portfolio and try to determine whether we belonged in this business.

From 2000-06, the funds department was ring-fenced. We were given $200-250 million p.a. to go and invest and see if we could do better, achieve proof of concept. We did about 8 to 10 funds p.a.

Because of the J-curve in private equity, it took until the end of 2005-06 to see that the strategy was working. But at that stage, it was expanded to about 20 funds p.a., totaling about $400 million, plus or minus. And this last year, in a counter-cyclical response to the global crisis, we aimed at 40 funds, totaling $900 million. We did not manage to close them all as some were still a distance from first close in a very tough fund- raising environment, so we have taken about ten forward into this year.

Q: Where are your investment funds sourced?

A: It's all our own balance sheet money, from the original funding granted to us when IFC was set up in 1956, plus retained earnings. We make fairly healthy profits every year.

Q: What's your MO, and how does it relate to the conventional private equity community?

A: We are essentially an LP, funding what we hope are going to be commercially successful private equity groups. So we only back funds we think are going to be able to demonstrate proof of concept in an area where we're looking to establish a commercially viable industry.

That said, however, IFC in its direct investing is quite different than the private equity funds that we back. In fact, between the two portfolios, there's only about a 3-4% overlap in the underlying companies. That's because, for private equity, you need to either have control or a shareholders' agreement that gives you significant influence and control-like rights, so you can drive the company.

IFC, by its constitution, is forbidden to take a management role in any investee company. We can have a board seat. We can act as a sounding board. And so we're a very good partner for a company that wants an outside interest to provide capital and advice – we have a lot of global industry knowledge, for example – but at the same time a company that really wants to direct themselves.

Q: If you could crystallize what your experience has taught you, what would it be?

A: That emerging market risks are grossly overstated.

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