What we here in the region know is that a tag like Middle East means as little as Far East these days. It makes as much sense to lump Japan in with Bhutan as it does to lump Dubai in with Sudan. The maturity levels of the markets are different across all the main measures of accountability and transparency. But this is nothing new. We know that they are different and we know that lack of insight from the big players in the US is not something that we need to lose sleep over.
As indicated, emerging markets funds attracted over $21 billion in private equity and venture capital investment in 2005. This was up from $6 billion in 2004. Impressive growth indeed. With fund flow of that strength, what is certain is that it would simply not be possible to turn off the private equity tap.
The reason why the market has grown so large is quite simply down to the rates of returns. If an asset class beats all the indexes, then it is naturally going to attract more investment. When critical mass is reached, then the asset class becomes mainstream. Every pension fund of any significance these days will have an allocation in private equity. If the fund manager is doing his job properly, then it is simply a necessity.
Increasing competition
For much the same reasons, the Carlyle Group is now looking closely at investing in Africa, the Middle East and South East Asia. This could be good news for players in the region who want to do co-op deals with them, or it could be viewed as unwanted competition for those who want the playing field to themselves.
For the likes of the Carlyle Group, the world is flat, as we have said, but it is one that is compartmentalised in a new way. Whereas in the past we had the planet segmented into first, second and third world, representing industrialised countries, industrialised communist countries, and non-industrialised countries, the split these days is more usefully seen as developed countries, emerged countries and emerging countries.
The basket of countries into which our region falls is the middle group of emerged nations. The defining characteristics of these emerged nations is that their governments are in favour of private equity, global firms are setting up shop within them and there is an availability of ready-debt.
China
While swathes of the Middle East and the GCC in particular fall into this category, China simply cannot be ignored. There seems to be little doubt that China will be the biggest market in the world within the next 15-20 years. It is hardly surprising to find that the Carlyle Group has offices in both Beijing and Shanghai although they are clear that they are in it for the long haul. You need to be patient if you want to see any returns from China.
With so much focus on China, is there a danger that it will overheat? It seems possible that there might be a correction, since there does seem to be too much capital chasing too few deals, but it is unlikely that any correction would mean that the smart money would withdraw. All it means is that investors need to be smart with their timing.
Whereas the European market has traditionally been dominated by buyouts, the market in the USA is much more 'bipolar' and has significant amounts of both buyout and venture capital deals. Emerging markets, on the other hand, display evidence of buyouts, venture and growth capital investments.
This reality is perhaps best outlined in the EMPEA's Second Survey of Limited Partner Interest in Emerging Markets Private Equity*. This is where we see the need for emerging markets to generate returns over 25% IRR in order to be attractive to private equity investors not domiciled in the region.
According to the large institutional funds like CALPERS, while emerging markets only make up 5% of their total portfolio they do indeed look for a higher rate of return on emerging market investments. More generally, as 'the search for returns' becomes more acute, and domestic returns begin to languish, then emerging markets do become more attractive. Furthermore, diversification is a key driver when it comes to investment in emerging markets. When faced with the reality that what are considered today to be emerging markets will be bigger than the economies of the G6 by 2025, then it becomes clear why these markets assume a very significant position in the investment scheme of things.
Frontier markets
The frontier markets are essentially all emerging markets excluding India and China. While the Middle East may be seen by the world at large as an amorphous whole and represents a sea of instability, there are many islands of growth within that sea, most of them in the GCC. Whereas a few years ago Abraaj Capital was a solo player in the private equity market here, now there are 29 firms in this space with funds under management of $5 billion in the UAE alone. The recent announcement of Abraaj's Shari'ah compliant 'Infrastructure and Growth Capital Fund' of $2 billion presumably means this figure is now touching $7 billion.
The reasons for this growth are as outlined before, and stem from the impressive regulatory reforms that we have seen. This has meant an influx of capital into the region, which simply would not have come if there were not robust exit mechanisms already in place.
How could the region be improved? The first area that could be addressed is simply to demystify the asset class. It isn't new to high net worth individuals in the region but perhaps we need more players who are used to using global standards of best practice to come and do business here.
In tandem with this is the need for the development of the infrastructure to ensure good governance and, high on the list, a region wide court system that respects the value of a contract. When this happens then the image of the region as a whole gets a lift. With a tax system that encourages entrepreneurships, then we would see the environment set correctly for maximum growth.
Looking ahead
What other changes do we need to see to ensure the continued healthy growth of the industry?
One issue that needs to be addressed is that the private equity industry still has something of an image problem in many markets. In some instances, private equity investors are seen to be those who come into a market only to milk it and leave. In the process they cuts costs and jobs.
What leading practitioners need to do is show that rather than being opportunists, they can add real value to an economy. The PE firms that survive in the long run are those that add value. Short-termist investors will only last in the short term.
Sourcing proprietary deals is key to survival and this is where real sectoral expertise is essential. Players simply must be attuned to the local culture, ambiance and sentiment. In this light, PE is seen not as milking the economy but as helping develop the economy. PE firms need to be good coorporate citizens and deliver real, sustainable business improvements. They have to be advisers to the sectors in which they operate rather than lecturers.
Perhaps most of all, there is a need for a dedicated body or industry association in the region that is the Private Equity Association of the GCC. This needs the buy-in from the big players as well as the small players. It will need a method of disseminating information throughout the region. Private Equity and Venture Capital Middle East magazine would be proud to be a part of such an initiative, since there is clearly a real need for the rest of the media in the region to get to grips with the concept and the reality of all that is PE.
This body would work hand in hand with Bahrain based GVCA to lift the industry to new levels and deliver to the region the kind of quality service and information that EMPEA does for the collective emerging markets as a whole.
The time is now.
* EMPEA's Second Survey of Limited Partner Interest in Emerging Markets Private Equity can be downloaded from www.empea.net