Region vs. Country
Pan-Asian or single-country PE funds anyone?
WE HOPE everyone has enjoyed the summer vacation, and is now safely ensconced back at their offices feeling recharged, not-too-badly sunburned, and wiser from whatever reading material they took with them to the beach. (Parts of August were rather wetter in Manila.)
A couple of months back, we got invited to a debate pitting regional private equity funds against PE funds focused on individual countries. Knowing that we espouse single-country funds (as a matter of professional necessity as well as heartfelt ideology), the organizers asked us to champion the cause of country funds. A little red light went on in the back of our head, but we blithely picked up the hurled gauntlet nonetheless. That episode refreshed for us the oft-forgotten lesson about sinning in haste and repenting at leisure.
We asked our friends at Cambridge Associates, an international consulting firm specializing in the PE and venture capital space, for some performance data, and they graciously furnished us the following:
As an avid consumer, digester, and purveyor of data, we immediately felt rising indigestion. The Cambridge numbers indicate that regional funds have in fact beaten country funds, at least in the past 10 years. But, after liberal swigs of antacid, we soberly recalled the old saws that: (1) past performance is not predictive of future returns; and (2) the measurement of historical returns is highly sensitive to when one takes a sounding.
Our thoughts then turned to the conditions under which country funds might be preferable to regional funds. After all, if country funds continue to exist, there must be Darwinian reasons to support them, and they presumably address particular niche needs / investor preferences.
The most obvious use of single-country funds, for a limited partner or fund of PE funds seeking broad Asian exposure via a multi-manager approach, is to have these as small “satellite” holdings clustered around larger “core” positions in regional funds. This is the way the LP or FoF can overweight selected countries in order to express greater conviction than her chosen regional funds reflect.
For example, an LP may discover that her “passive” exposure to Philippines is 1% (driven by the average allocation that her regional PE fund positions have in Philippines). If she is convinced Philippines should greatly outperform its neighbors within the next 5-10 years (and obviously a 1% allocation would be too measly to “move the meter”), then she could quintuple her total exposure to said country to 5% by putting some of her money into a pure-Philippines PE fund.
Of course, the region-vs.-country debate is not solely about country diversification vs. country concentration. In polite circles, the furor is every bit as much a subtle question about the quality and competence of the PE management team. Regional managers, the stereotype goes, have better-quality teams who’ve been exposed to a broader variety of industries and countries; in Asia, the stereotypical regional team is based in Hong Kong or Singapore. On the other hand, country managers supposedly offer superior local knowledge and therefore easier access to better-quality deal flow, plus the permanent boots-on-the-ground required to effectively shepherd investee firms throughout the holding period.
Whenever real money is involved (meaning, in all cases), stereotypes are downright useless. Every LP will tell you that due diligence will expose a wide range of strengths and weaknesses across individual PE managers, be they regional or single-country teams.
The Philippines is a good example of a robust labor market for investment talent, the quality of which is comparable to that available in Hong Kong or Singapore, yet at a fraction of the price. We know this because of the many Filipinos working in the investment and banking sectors within the country as well as in all of the global money centers. (Granted, Philippines may not be typical, as an oversupply of highly-marketable human capital happens to be one of the country’s competitive strengths.) A good number of expatriate Filipinos, having gained academic training and/or work exposure overseas, do re-settle back home. At the same time, a few foreigners who are finance professionals fall in love with the country and decide to stay for good, adjusting themselves to prevailing compensation rates if need be.
Human resources are the biggest cost item in the PE business, and a lower cost base relative to Hong Kong- or Singapore-based regional teams creates some elbow room for local managers to staff up. Those added warm bodies certainly come in handy when evaluating and supervising investee firms; after all, close scrutiny is not really just a luxury in emerging markets such as the Philippines, where governance and transparency challenges are perceived (although this is arguable) to be greater.
In Philippines, and possibly in a few other countries, local PE management teams are able to have their cake and eat it, too. They can inexpensively recruit world-class talent, yet at the same time leverage their local presence to dig more deeply for hidden PE jewels.
The opinions expressed herein are the writer’s own, and are not necessarily official positions of Angeon Advisors Ltd. Neither the writer nor Angeon makes any representations or warranties as to the accuracy or reliability of the materials contained herein.
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Angeon Advisors is an independent alternatives manager specializing in private equity and venture capital growth themes in the Philippines and other markets in Asia. Angeon also provides financial advisory services to very select clients.