Are LPs peeking over the BRIC wall?

The growth in emerging markets investments has been a nearly decade-long conversation. Ever since Jim O’Neill coined the term in 2001 it has seemed like the explosion of emerging markets is always just around the corner.

Now, the trend may finally be coming to fruition. As Nate Suppaiah, Managing Director of Alternative Emerging Investor, explained, “Global interest is shifting towards emerging markets. LPs will begin pushing GPs to move to emerging markets to meet returns, while creative GPs will look to emerging markets for possible opportunities and future funds.”

The question remains: If LPs are looking to emerging markets, how will these developments impact capital deployment in developed world?

LPs, the JOBS Act, and Emerging Markets

Just a few years ago, few LPs would have seriously considered an emerging market investment. However, thanks to fundamental shifts in social dynamics and technology, the strategy has become more feasible. According to a recent survey by EMPEA,”The majority of LPs (nearly 60%) expect the dollar value of their EM PE commitments to increase over the next two years.”

The findings do not surprise Suppaiah. “The digital age and subsequent availability of information has been a game changer for investing in emerging markets,” he explained. “While quality investment information is still superficial, immediate access to emerging market professionals, contacts, and vehicles opens the door to these regions for many investors.” As a result, “The number of LPs looking to invest in emerging markets is certainly growing.”

The increased interest may be buoyed by an unlikely law: the JOBS Act. While there has been a lot of talk about the impact of the JOBS Act on domestic investing, Suppaiah believes that the new legislation could have significant impacts on international and emerging market investments as well.

He explained, “Right now, if you are looking to invest in emerging markets, chances are BlackRock’s global fund comes to mind. In reality, there are dozens of smaller options to consider. The JOBS Act will afford the smaller funds a place at the table.” As he explained, “Advertising in US for foreign funds will be a fantastic way to drive competition. As more funds — both domestically and internationally — have greater ability to advertise, there will be greater competition and, as a result, a better market.”

Not All Capital Will Leave

Despite the appeal of emerging market investments, Suppaiah admits that only a select few LPs will capitalize on the opportunity. “While there will be some challenges in reallocation, I do not see major swings of capital distribution,” he mentioned.

The biggest deterrent for emerging markets investments is the heightened sense of risk many investors hold for the regions. Suppaiah explained, “One problem that still plagues emerging market investments is the disparity between perceived and actual risk.” He previously explained that  many investors overestimate the risks of an emerging market investment and are clouded by preconceived notions.

The IMF recently published a report confirming Suppaiah’s estimation of LP’s undeserved concern for risk in emerging markets, noting that, “ While broad macro and governance risks in emerging markets continue to decline, there is a substantial lag in perceptions. Emerging markets are regularly characterized as suffering from macro/political/governance issues, perpetuating a simplistic perception of actual risks.”

Suppaiah agrees with the IMF but doesn’t think the traditional players will be involved in the next, broader wave of investments. “I believe we will see a development of smaller investor sophistication in the US,” said Suppaiah. “Many of these individual investors are becoming skeptical of the US capital markets are moving to alternative investments, including those in emerging markets.”

If you have one of these investors as an LP, whether you know it or not, it might pay off to listen carefully to their questions and interests.  While it might not be in your arsenal to expand to new, developing regions, it is important to stay aware to your investor’s interests and find creative ways to help meet their goals. Sometimes even small add-ons or joint ventures by existing portfolio companies can meet their shorter-term needs.

Inter-Emerging Market Activity on the Rise

In addition to one-off individual investors, Suppaiah believes much of the investments in emerging markets will come from other emerging markets. He explained, “The developed world is still the powerhouse of capital and investment expertise, but the slice of the capital pie coming from other emerging markets is certainly growing.”

He continued, “There is quite a deal of inter-emerging market trade. Last year, China overtook the US as Brazil’s primary trade partner; Brazil has the largest private equity fund in Africa. These transactions bypass the developed markets almost completely.”

The interconnectivity of emerging markets was also recently discussed by Andrew Dawson of PWC. He wrote, “Trade between the SAAAME (South America, Asia, Africa, and Middle East) markets is growing much faster than the developed-to-developed and developed-to-emerging market flows.”

The development of inter-emerging market investments has been a result of many emerging markets developing stable infrastructure. Outgrowing previous boom-bust cycles, “Many of these [developing] countries are now seeing consistent, responsible growth rates and now have money to deploy in other nations. The techniques they have learned in their own countries can be applied to many other developing markets.”