Emerging Market Investment Comes of Age

By Derek Newberry

You can also read the blog version of this article.

Two recent meetings on emerging market finance have shown just how far the emerging markets finance sector has come: and how far it could go. It seems that emerging economy finance overall has already gone mainstream and is positioned to achieve greater scale. On the other hand, the green sector finance landscape in emerging economies, while full of potential, is just beginning to make significant advances.

The EMPEA Global Private Equity Conference

The EMPEA Global Private Equity Conference last Thursday and Friday showcased encouraging investment growth and opportunity in emerging economies overall.

It appears that the broader sector of emerging economy private equity and venture capital (PE/VC) has already proven itself to mainstream investors. At least that seemed to be the general consensus from this conference. EMPEA used the occasion to unveil the results from this year’s survey of emerging market investors, which showed that emerging market investment is being seen less as a risky venture and more as a dependable source of returns in the global financial community.

The survey highlights give a good idea of what to expect in the future:

• 63 percent of those surveyed agreed that five years from now, emerging market private equity (PE) funds would deliver higher returns than “developed” markets.
  
  
• Over half of the limited partners (LPs) said that returns from their emerging market investments were meeting or exceeding expectations.
  
  
• Nearly 80 percent of LPs projected that their emerging market commitments would grow over the next five years.
  
  

Yet several challenges were identified for emerging economy investments - many investors confirmed that funds must have a local presence in order to navigate the different bureaucracies and cultural tendencies of each country. Funds also have to be selective in their investments, working with companies that know how to operate in an “unstructured world,” as one participant commented.

By the end of the conference, it was generally clear that emerging markets had earned their status as sources of dependable and attractive investment opportunities. The next step is for the new generations of “green” entrepreneurs to soak up a greater share of the capital coming into these markets in the future.

The IFC-WRI Sustainable Investment Workshop

The “next generation green entrepreneur” was a major topic at last week’s IFC-WRI workshop on sustainable investment in emerging economy green sectors. Sustainable small and medium sized enterprise (SME) finance is evolving from its status as an interesting trend to becoming a sizable sector in the future, but for now the investors involved in this area are a pioneering group, searching out stable returns in unknown territory.

Nearly twenty fund managers with investments in companies all over the world and in a variety of high-growth industries, including clean technology and organic agriculture, met on May 8th to explore the opportunities and challenges in their work. A WRI survey before the event showed that firms in this sector are generally either local venture capital funds (like Asia West), or larger capital aggregators that use a variety of finance mechanisms to support their clients.

The challenges that were mentioned repeatedly in our funds survey were the same that arose in our event’s roundtables. These were the challenges around building the deal flow of sustainable businesses and fundraising for new investment models. Francisco Grajales, an analyst for Econergy International went in-depth on the issue of finding good investments in this sector. He noted that one common solution to this problem among fund managers is to engage in intensive technical assistance with each investee.

On the fundraising side, the European Investment Bank’s Cyrille Arnould explained that as sustainable emerging economy investment is a relatively new phenomenon, and firms in this sector are still struggling to build up a proven track record of returns to attract mainstream investors.

Despite the significant barriers, participants were convinced that sustainable SME finance would be seen more and more as a viable investment vehicle in the years to come. Cyrille compared the state of this type of investment to where the microfinance industry was three years ago - a great idea to blend social returns with profits that had few proven models for investors to follow.

Lending credence to the optimistic tone of the workshop participants, we found in our research that several of the funds surveyed reported returns of around 25 percent, with the majority of the more established funds reporting successful exits.

Yet they have not quite arrived. Fund managers broadly acknowledged that several obstacles would have to be overcome for sustainable SME finance to scale up as a sector; firms will have to experiment with creative finance and exit strategies. There still needs to be a comprehensive effort to offer some minimally standardized formula for defining and quantifying the social and environmental impacts of these investments.

Overall, it is clear from both conferences that there is plenty of opportunity in the sector. With the conclusions of the EMPEA participants, and the optimism and financial success of the sustainability crowd at the IFC-WRI workshop, there is little doubt that these funds will experience the same, if not better, success as their counterparts in the US and Western Europe.