Working with Local Partners in Emerging Markets
Hedge funds, venture capital funds, and related investments are set up for long-term investments. These funds often can't sell their investments easily, so the fund managers need to make sure that they feel comfortable with the people they'll be working with, especially when they're working in an emerging market.
Just as general and limited partners go into business together, an entire partnership goes into business with the firms that it invests in and with those who have a key stake in the business. The key partners for emerging market funds are local governments, local investors, and nongovernmental organizations (NGOs). These people influence the fund's success or failure.
Whether explicitly or implicitly, a country's government plays a role in any emerging market investment. Because the government determines regulations, investors need to cooperate with the people in charge. In many cases, government leaders aren't thrilled to have high financiers from developed economies mucking around their country. Their key concern is hot money: funds that make huge investments when the market is going up and then pull out everything at the first sign of trouble — a strategy that can wreak incredible havoc in an emerging market.
Investors in publicly traded stocks and bonds already have government acceptance, as the very process of setting up a framework for securities trading is a bureaucratic dream! Markets work only if they have enough regulation to make sure that everyone coughs up the goods and the cash that they've agreed to, and that's a key function of government.
Private investors don't necessarily need government approval to get underway. However, regulators and politicians can come in after the fact and interfere, requiring licenses, refusing to protect contracts, or even preventing investors from removing money from the country.
Governments don't always thwart investors. In many cases, they become partners with them, which can add a whole layer of profit potential — and complication — to the deal. Emerging market governments often turn to outside investors like you to help fund infrastructure projects, for example, with the government itself as the ultimate payer.
On occasion, an emerging market government invests alongside private investors in a private company, especially if it deems the project to be in the national interest. A related transaction is known as BOT, for Build-Operate-Transfer. In these deals, a private company builds the project, such as a road or a power plant. It handles the initial operation and then transfers it to the government. These deals aren't common, but they do happen, and private partnerships are likely to know about them before anyone else.
Managers of hedge funds, venture capital funds, or private equity funds in emerging markets often work with local investors to help find deals and to be a co-investor in different transactions. These people have tacit knowledge that an outsider may never be able to gain, and they can help smooth the way to better transactions, reducing risk and increasing the potential for return.
Expatriates often invest in private funds that invest in their home country, or they make the same investments that the private funds are making. These people often have the contacts and knowledge to increase the likelihood of success. They aren't exactly local, but they have local experience. If the expatriates are excited, you should be, too. And if the expatriates are staying away from a market, then it's probably not a great place to invest.
Some local investors see outside investors as competition. In many emerging markets, the richest and most successful companies are dynastic holding companies that would like to acquire some of the same businesses that venture capital and private equity funds are eyeing. This competition can make it more difficult to get a deal done, especially because these holding companies are likely to have really tight ties to the local government.
In many cases, the private investment funds with the big bucks are partners with the major NGOs, like the World Bank or foreign government aid agencies. These organizations fund a range of infrastructure and economic development projects — water purification plants, industrial parks, highways, and just about anything else that makes it easier to live and work in a country.
The NGOs often look for private investors as a check on the economic viability of a project, which is why they often like to bring them in. A lot of aid organizations get so carried away with the opportunity to do good that they've been known to take on projects that make no economic sense and end up hurting the country in the long run. The better NGOs are well aware of this pitfall. Private investors are more concerned with risk and return than they are with romantic notions of doing good (although many would like to do good in the world). If they aren't interested in co-investing, then it's probably not a good project.
One organization that has long worked to bring private sector investors to the developing world is the World Bank's own investment bank, the International Finance Corporation (also known as the IFC). While the World Bank finances government projects, the IFC works only with private companies. In many cases, it invests in partnerships with other investor groups. It also issues bonds and other securities to help finance its investing activities, and it publishes a lot of great information about investing in emerging markets.