GLOBAL - A large majority of private equity limited partners (LPs) feel that their general partners (GPs) for emerging market funds are at least as well-aligned with them as their GPs for developed market funds, according to the latest EMPEA/Coller Capital Emerging Markets Private Equity Survey.
Approximately 84% of private equity limited partners (LPs) feel that their general partners (GPs) for emerging market funds are at least as well-aligned with them as their GPs for developed market funds, according to the latest EMPEA/Coller Capital Emerging Markets Private Equity Survey.
At the same time, 23% of respondents reported better alignment with emerging market fund GPs, while only 16% felt their interests were less well-aligned. The findings are significant for an industry that has been plagued by accusations that compensation structures are stacked against investors.
Emerging market private equity funds are on average smaller than developed market funds, which means a better balance between carried interest (the performance fee charged by GPs) and the fixed fee levied on committed capital.
But Sarah Alexander, president of the Emerging Markets Private Equity Association, also pointed to the origins of the industry: "So much of the capital that was initially raised in emerging markets came from development banks that were really able to set the terms for what those funds would look like, and to some extent those terms have carried forward as those funds have become pure institutional-quality funds," she told IPE.
That may point to an early-mover advantage, as more capital floods into these markets. The survey found 77% of LPs expect annualised net returns of more than 16% from their emerging market portfolios over the next 3-5 years (as opposed to just 29% of LPs in developed market funds), and almost one-in-five expect returns of 25%-plus; two-thirds feel their emerging market portfolios will be less damaged by the recession than their developed market portfolios.
Given those expectations, it is no surprise that 57% of those surveyed expect their new commitments to emerging markets to accelerate during 2010-11, and the median proportion of private equity commitments targeted at emerging markets is set to double, to 11-15%, within two years.
As the "mega-buyout" firms establish local offices, it will be tempting for LPs to opt for what they know and follow the herd by allocating to emerging markets via these household names, and Alexander warns that there is little to suggest that they will offer much better terms than they do in developed markets.
"Where terms go might come down to whether the homegrown funds or the mega-buyout funds turn out to be the more attractive to LPs," she suggested. But even if LPs take a chance on local players, the economics that the mega-buyout shops bring with them could hurt LPs anyway.
"If a global mega-buyout shop can partially subsidise a local office, thereby offering double the salaries of homegrown shops, you have price escalation in the market which in turn will lead to economic terms rising to cover those costs," said Alexander.
Erwin Roex, a partner at Coller Capital, added these pressures had already caused some "team disruption" in emerging markets, and warned LPs they would have to remain tough with their GPs.
"In recent years LPs have realized that GPs couldn't care less about the carry and just got wealthy on the fees, so there is more pressure to make sure that this doesn't happen again. On the other hand, we've seen this before, and the reality may turn out to be no different," said Roex.
The survey found China, Brazil and India to be the most popular destination for emerging market private equity commitments, with Africa, the Middle East and Russia bringing up the rear.
This was the sixth annual EMPEA/Coller Capital Emerging Markets Private Equity Survey, capturing the view of 151 global LPs: 65 were European and 26 were pension funds.