Emerging market LPs eye China, Russia, credit, leverage

Gavin Wilson CEO of IFC Asset Management Co, said Russia’s move into the Ukraine and tensions between China and its neighbors mark the “return of risk” in emerging markets. But he added, “I don’t think we’ll have World War III.”

“Will investors be nervous about Russia and Ukraine? Yes,” he said. “All of us like to invest in growing economies and growing countries and…Russia is the fastest growing country in the world.”

He said IFC will continue to invest in Russia unless economic sanctions against the country now under discussion by the United States and other allies take effect.

Teresa Barger, managing director at Cartica Capital Management, said the slowdown in the China economy had had ripple effects throughout emerging markets. Vietnam has been the biggest beneficiary of higher wages in China as a lower cost manufacturer. She noted that the cheapest source of skilled labor in Asia is in Taiwan. Investors have become “more skeptical” of Peru, an exporter of minerals to China, along with Chile and South Africa. Brazil, an exporter of soybeans and iron ore to China, also has taken a hit.

Limits on leverage in emerging markets remains a challenge, she said. In the United States, private equity firms frequently leverage up portfolio companies by 4x to 6x the taget’s EBITDA, but LPs often prevent leverage levels from going near 2x in emerging markets, Barger said.

“LPs have an allergy for any kind of leverage in a fund,” she said. “It puts emerging markets at a big disadvantage.” Restrictions on currency hedging also present another challenge.

Overall, Barger’s firm, which manages nearly $3 billion, has been allocating more money to Mexico and India, partly because of reform efforts. Overall, she said she has seen a three-year drought in India investment, with possible pent up demand awaiting the results of an upcoming election there.

Walid Cherif, managing director and co-head of Gulf Credit Partners, said the firm is accustomed to investing in areas of political conflict in the Middle East.

“It’s something we’re used to—it’s only a question of when and where it will take place,” he said. The Arab Spring states of Egypt, Tunisia and Libya have improved, while the Persian Gulf states such as Saudi Arabia and the United Arab Emirates have been investing heavily in infrastructure. “As long as this continues, we’ll be seeing a lot of opportunities,” Cherif said.

Robert Petty, managing partner and co-founder of Clearwater Capital Partners, said China remains the elephant in the room in emerging markets after three years of economic challenges. He said shadow banking in China and elsewhere remains “the most profitable investment in emerging markets.”

He said his firm has been putting capital into a Chinese lender and gaining exposure to companies there through loans. His firm is anchoring the investment, with support from a sovereign wealth fund, which he did not name.

“This is when you’re supposed to be contrarian,” he said. “Financial services is an interesting way to play in emerging markets.”

Prakash Mehta, partner, co-head investment management practices at the law firm Akin Gump Strauss Hauer and Feld LLP, said June 28 marks the 100th anniversary of the start of World War I. He said the financial sector has been at war with regulators since the 2008 financial crisis, causing the big banks to shrink.

“Private equity titans are the new kings of Wall Street,” he said. “We should keep that in mind in emerging markets … Shadow banking is the fastest growing piece of our business.”

On a separate point, he said the Norwegian sovereign wealth fund has yet to dive into alternative investments and if it does, it could have an impact on private equity investments in emerging markets.