Down but not out

“The last 12 months have been tumultuous for emerging markets,” says Darius Lilaoonwala, head of the IFC Global Infrastructure Fund, neatly summing up the effect that likely US interest rate rises and the devaluation of the yuan – amid fears over Chinese economic performance – have had on the emerging markets scene, as well as the declining value of many commodities.

“Most emerging market currencies have toppled and, if you have already invested in emerging markets through dollars, euros or pounds, you will inevitably see a hit to the value of your portfolio,” adds Lilaoonwala, pointing out one clear ramification of what is a volatile scenario for infrastructure investors.

IFC Global Infrastructure Fund completed a final close on $1.2 billion in October 2013, beating a target of $1 billion. Since then it has been busily putting the capital to work in emerging markets across the world and has now invested around $440 million, according to Lilaoonwala, making it about one-third invested. Recent investments have included Chinese gas business China Tian Lun Gas and Turkish power and water services firm GAMA Enerji.

But Lilaoonwala, despite present difficulties, can see at least two reasons why investors should not be giving up on emerging markets. One relates to the theory that, if a nadir has been reached, that’s generally a good time to be reaching for your wallet. “We may have seen the bottom of the cycle and, if you have dry powder, you can go in and invest in good assets,” he asserts. “In countries such as Colombia, Nigeria, Brazil, China and India, we see a lot of possible bargains. If you have capital, you can go and hunt for these opportunities.”

Also, his sense is that investors are sympathetic when it comes to emerging market risks and the possibility that things can go wrong in the short term. “They read in the media about emerging markets, including all the doom and gloom headlines, and they are quite understanding. As emerging market investors, they expect to see their portfolios get impacted by currency issues.”

He also thinks that investors are right to have a measured view, as they need to take into account the long-term nature of infrastructure investment. “We have a 12-year fund life,” he points out, “and we want to be judged on that basis, not on the volatility of a single year. The IFC [IFC Global Infrastructure Fund’s parent organisation] has invested successfully through multiple cycles and it doesn’t get thrown off course by the changed circumstances that you see from year to year.”

Lilaoonwala also makes the point that the macro-economic picture differs from one market to another. For example, major oil-importing nations such as India have benefitted from the oil price slump – allowing the country to re-allocate money away from subsidies and towards infrastructure projects instead.

James Wardlaw, a London-based partner at placement agent Campbell Lutyens, says that, despite the troubles, he is aware that some of the larger direct investors appear to have an increasing appetite for emerging markets. For example, he points to recent moves Canadian pensions such as the Canada Pension Plan Investment Board and La Caisse have made into the likes of India and Mexico. “The largest investors, who would normally invest directly in developed markets, are now extending their footprint into selected emerging markets,” says Wardlaw.

“The driver for the really big guys is diversification,” adds Wardlaw. “At the moment you see a lot of concentration in developed markets such as the UK and Australia and that provides a good reason to go into emerging markets. If you have $7 billion to $9 billion to invest, then why wouldn’t you? The diversification impact has to be a positive.”

However, when it comes to investing through traditional fund managers, it appears to be a rather different story. “We’re not seeing a widespread series of commitments to emerging market fund propositions,” adds Wardlaw. He thinks this is partly due to a lack of investment options. While the likes of Equis Funds Group, Macquarie Infrastructure and Real Assets and Actis have all carved out solid reputations and shown their ability to raise large amounts of capital, the number of fund managers targeting emerging markets is very small.

Wardlaw also points to the lack of performance transparency when it comes to emerging markets infrastructure. “If you could show through benchmarking that an emerging market fund was offering x percent – and that that represented genuine alpha – you could get support for it. But that’s not the case; we’ve not seen the data coming through yet.

Investors in the emerging markets today, therefore, have to exercise judgement on the fundamentals of a proposition. Those that are prepared to do so can, we believe, find propositions which offer alpha compared with equivalent adjusted risk in the developed markets.”

He also adds that the lack of transparency may be changing in part thanks to his own organisation. The Singapore-based EDHEC-Risk Institute, which is at the forefront of infrastructure asset class benchmarking efforts, is backed by Campbell Lutyens and Paris-based fund manager Meridiam Infrastructure.

For the time being, many investors view emerging markets as simply too risky. “People would like to raise funds [for emerging markets] and there are a lot of propositions that we see coming through London,” says Wardlaw. “But only a small percentage of these would-be funds end up getting raised. It’s a young asset class where investors are still building their portfolios, and it’s not surprising that they initially focus closer to home.”

However, Ben Way, chief executive officer of Macquarie Group Asia, believes that much of the negative media coverage of emerging markets has been overdone – particularly when it comes to China. He points out that the country – while adapting from 10 percent growth to somewhere around 6 to 7 percent – is still seeing strong export, investment and consumption dynamics.

“China still has an enormous appetite for development,” he insists. “It also has significant capital. With the upcoming 13th five-year plan, there is a strong expectation that there will be a big focus on infrastructure to enable sustainable urbanisation.”

Way points out that while Macquarie has portfolio companies in developed Asian markets such as Australia, Korea and Taiwan, the biggest growth the firm has seen in the last five years is in emerging markets such as China and the Philippines. He acknowledges that the recent launch of the Asian Infrastructure Investment Bank was partly about China gaining greater influence in an organisation of that type – but it was also, he says, about addressing Asian infrastructure demand that is expected to amount to around $7 trillion over the next ten years.

He also believes there is more deal flow than available capital, citing the example of Sichuan province. “Sichuan has the population of Germany, and it’s worth stopping to think about what the asset class has achieved in Germany,” he says. “You could spend a $3 billion fund in Sichuan alone.”

In common with Lilaoonwala, Way believes that reading too much into the short-term picture in emerging markets can potentially be misleading since they are dynamic and constantly evolving – meaning that the opportunity set changes quickly as well.

For example, confidence in India a few years ago was low but now foreign direct investment is flooding back into the country on the back of high expectations surrounding the Modi administration. In China, meanwhile, a crackdown on corruption has slowed decision-making and ironically made deal-doing more difficult than it was a few years ago amid the understandable desire to create greater transparency.

Above all, Way believes investors should not be deterred by processes being different in emerging markets from what they are typically used to in developed markets. “In many places in Asia things happen differently than in Western markets and people sometimes think that, because it’s different, it’s wrong,” he says. “But that’s not the case. We look at how each market dynamic works and ask whether we can work with that and be effective.”

Fund management sources canvassed by Infrastructure Investor for the purposes of this article described the spectrum of investor insight into emerging markets as very broad.

Some investors, they say, are highly sophisticated, on the same page, and are very supportive of emerging market strategies. Others may not (yet) have either the resource or the mandate to engage with emerging markets in any meaningful way. For others – who may have the capacity to invest but are not persuaded by the opportunity – the key may lie in providing analysis of the markets to allow informed choices to be made.

Kelly DePonte, a managing director at US-based placement agent Probitas Partners, thinks that the type of strategy you tend to see deployed in emerging markets does not fit with where the bulk of investor demand lies at the current time. “There are a lot of investors who want exposure to core assets and a lot more of the opportunity in emerging markets is in the greenfield space,” he notes.

DePonte also points out that investors still prefer evidence of experience and track records where they can get it – and emerging markets inevitably fall short in this respect. “It is much easier to find an experienced manager focused on North America or Europe,” he says. “There are a few funds targeting Brazil but Brazil now has real political and economic difficulties so the sentiment now is much less bullish.”

Perhaps counterintuitively however, Probitas’ recent Infrastructure Institutional Investor Trends for 2015 Survey showed interest in emerging markets rebounding slightly – with much more interest in Asia than any other geography – after having fallen to an all-time low in the same survey a year previously.

While 58 percent of investors canvassed by the survey last year expressed fears about political, economic and currency risks in emerging markets (two-and-a-half times more than the previous year), the 2015 version saw these concerns being expressed by a significantly lower 32 percent. Nearly a third of investors (29 percent) said they were interested in emerging markets because of their long-term growth potential, while 26 percent were interested because of their ability to diversify risk (compared with just 8 percent the previous year).

DePonte believes that the enthusiasm implied by the survey should be treated with caution, since sentiment towards emerging markets tends to be volatile and can change very quickly. However, he does note that investors are seeing pockets of opportunity – including in Chinese renewable energy:

“There are a number of renewable energy funds focused on China and, given the smog that’s affecting cities such as Beijing and Shanghai, it’s clear that if you’re interested in renewable energy, then there’s a value proposition in China,” he says. Through the fog and the current tumult, astute investors will no doubt continue to recognise good opportunities in emerging markets – no matter how loud the headlines scream of panic and woe.