LPs and emerging markets: Expectations game

For the first time since the question started being asked five years ago, two Asian markets were identified as the most attractive destinations for GP investment over the next 12 months by respondents in EMPEA's annual LP survey. For Southeast Asia, the claiming of the top spot follows three years spent in second place; for India, second place represents a marked turnaround on recent investor sentiment.

The logic behind India's rebound isn't hard to fathom. The market has thinned considerably since the mid-2000s when $23.5 billion was raised in the space of three years by India-focused managers and GPs of all kinds invested more than $36.6 billion in the country. Those still standing are the ones whose track records and team strength are sufficient to withstand closer LP scrutiny. India's economy has also grown faster than in recent years and there is more faith than before in the government's ability to deliver reforms.

Investors who four years ago were criticizing the PE market for underperformance are now more willing to have another go, albeit with a smaller number of GP relationships. As such, the pace is more measured than before but nevertheless gaining momentum. LPs committed $3.9 billion in 2015, the most in seven years, according to AVCJ Research. In the first four months of 2016 close to $2.4 billion was committed and plenty of GPs are still out there trying to close funds. Investment reached an eight-year high in 2015, although a significant portion of that went into late-stage technology deals.

The positive sentiment on Southeast Asia is more of a puzzle. Deal flow in the region continues to be dominated by Singapore - investment dropped to $5.1 billion in 2015 from $8.3 billion the previous year, in part because the Singapore total nearly halved - and elsewhere it is patchy. The headline investment number for Indonesia jumped last year, but it was driven by a couple of very large deals; other markets deliver with similar levels of frequency, if at all. The family conglomerates, as competitors for deals or competitors within industries, remain a sizeable obstacle.

Annual private equity fundraising in Southeast Asia hasn't crossed the $1 billion mark in four years, which suggests the depth of the GP landscape is akin to that of the private equity opportunity. However, it could be argued that LPs expect to access Southeast Asia through pan-regional GPs that are set up to pursue larger transactions.

What is also worth noting in the EMPEA survey is that for all their bullishness on India and Southeast Asia, LPs are conscious of the risks. Asked to name factors that would likely deter them investing in particular markets over the next two years, respondents identified India as the biggest liability out of the 10 emerging markets EMPEA tracks globally in terms of historical performance, weak exits and high entry valuations. Southeast Asia is also seen as lacking on historical performance, while there are concerns that the scale of the investment opportunity is too small.

Despite these risks, more than half of LPs expect 2015 vintage India funds to deliver net returns of 16% or above, and just under half are looking for similar performance from Southeast Asia. Only China is higher of the 10 emerging markets, while the US and Europe are not expected to deliver anything like that.

Into this must be threaded another consideration: 40% of LPs are planning to increase their new investments to emerging markets private equity in 2016, down from 46% last year. This tallies with a fall in satisfaction with emerging markets performance: 70% of respondents said the asset class had met or exceeded expectations, compared to 78% in 2015, while 30% said their expectations had not been met, up from 25% last year.

With global growth widely expected to suffer over the coming year - and LPs citing slow or negative economic growth in emerging markets as the single most concerning issue in portfolio management - it remains to be seen whether India and Southeast Asia can meet expectations. There is not necessarily a positive correlation between GDP expansion and private equity returns, but neither is there between favorable investor sentiment and private equity returns.

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• Topics
• LPs
• Fundraising
• South Asia
• Southeast Asia
• India
• Emerging Markets Private Equity Association (EMPEA)