LP interview: CDC Group

At the start of 2011 it was clear to many that CDC Group had lost its way. The UK development finance institution (DFI) was launched in 1948 as the Colonial (later Commonwealth) Development Corporation to develop agriculture and industry in poorest parts of the British Empire. But 60 years later it was being accused of straying from this remit and prioritizing high returns over tackling poverty.

Revelations in the British press over CDC executives' pay and expenses claims did not help the situation.

The upshot was a dramatic reform, instigated by Andrew Mitchell, then secretary of state for international development. Key changes included improvements in transparency, an increase in the number direct investments, a shift towards a broader range of financial instruments, and a narrowing the fund's geographical focus to just Africa and South Asia.

"We had limited resources and we wanted to channel our capital to areas where it was needed most." says Alagappan Murugappan, managing director and head of the CDC's Asia funds team. "We also believed that Southeast Asia, China and Latin America - where we had previously invested - had developed enough to attract a significant amount of private sector capital. So the role we could play was limited."

Another important development was that CDC would no longer function predominantly as a fund-of-funds, which is had since 2004 when it spun out Actis, selling a 60% stake for GBP373,000 ($563,000). The remaining 40% was bought by management for $100 million in 2012.

Revised strategy

Murugappan - who was previously CEO of private equity firm UTI Capital, and also worked as an India-based principal with Actis between 2004 and 2006 - joined in late 2013. He was one of a number top-level hires following the strategic repositioning. His is responsible for Asia fund commitments and also sits on the group's investment board which oversees its direct deals.

Of the GBP608.3 million in new commitments CDC made in 2013, GBP438.5 million was deployed in funds, while GBP169.8 million went to direct deals, including both debt and equity investments. Murugappan explains that CDC will often co-invest with other debt providers but typically takes the lead, or invests alone, on equity transactions.

"By going direct, it allows us to target our capital at businesses that provide significant employment opportunities and which have the potential for strong growth and the creation of even more jobs" says Murugappan. "The bulk of our investments are still in funds but the direct investment portion is catching up quite fast."

As of March, CDC's global direct investment portfolio had swelled to $712 million, with $264 million being committed to South Asia. According to AVCJ Research data, notable recent deals include microfinance company Ujjivan Financial Service, which received $95.2 million from a CDC-led consortium; hospital group Narayan Hrudayalaya, which got $48 million; and Equitas Micro Finance, which raised $53 million from CDC and several other DFIs.

In order to effectively capture these direct deals, the group had to build out its internal resources. "We have grown a lot - we now have over 130 people, including our investment and support teams," Murugappan says. "We also have a large environmental, social and corporate governance (ESG) team, as this is the area where we like to add the most value."

On the funds side, CDC currently has investments in 38 PE vehicles run by 27 fund managers. In the last 18 months or so, $30 million has been committed to Rabo Equity Advisors' $250 million India Agribusiness Fund II and $200 million to IDFC Alternatives' $900 million India Infrastructure Fund II.

Murugappan says CDC has become much stricter when setting the criteria for which managers it should back, and in ensuring that they fulfill the group's development mandate.

"When we measure the development impact of a fund we are very focused on two aspects," he says. "The first is job creation and making sure that the capital is going to companies that will create employment. The second aspect is channeling capital to areas that are typically not receiving private capital."

As a result, CDC primarily focuses on funds targeting key sectors such as infrastructure, manufacturing, agriculture, healthcare, education and financial services. Currently, around 50% of the funds supported are run by first-time managers.

Criteria for a re-up

CDC is also looking to trim back the number of manager relationships it maintains. However, performance is not necessarily the only criteria when deciding whether or not to re-up. Murugappan cites India Value Fund Advisors as an example. The GP has reported a gross IRR of around 25% across all of its funds but CDC decided the manager had outgrown the need for DFI investment.

"We backed them in their second, third, and fourth funds, but when it came to the fifth fund we felt they were settled," he says. "Their operation was good enough to attract commercial capital, and therefore we no longer had a role to play."

While generating attractive returns may not be CDC's core motivation, financial performance and development impact are not mutually exclusive - investments that generate the highest IRRs are also those that create the most employment. "We do not expect the full commercial private equity return but when we evaluate a proposal we are look at it from financial perspective, and then we add the development aspect," Murugappan says.

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• Topics
• LPs
• Fundraising
• South Asia
• India
• Fundraising
• LPs
• CDC Group
• Direct investment
• Co-investment