Common Emerging Market Partnership Funds
The most popular type of private partnership these days is a hedge fund, but it’s hardly the only one out there. Venture capital and private equity funds also play in some emerging markets. These funds all have a similar structure but have different operating philosophies.
Note that you can’t just call up these companies and invest in them. These aren’t like mutual funds. Investors have to be accredited or qualified before these types of funds will even approach them. If you’re an accredited or qualified investor, you probably have a financial advisor who can help you make introductions by vouching for your status.
In their original incarnation, hedge funds were designed to generate steady returns no matter what the market did. These days, many funds take significant amounts of risk and have returns that fluctuate all over the place. You may be okay with such fluctuations if you like the flexibility and the long-term risk and return trade-off.
Some hedge funds specialize in emerging markets and aren’t interested in investments elsewhere. Others, known as macro funds, invest in pretty much any market that offers the possibility of a profit, which often means the emerging markets.
In general, hedge fund managers look for markets where they can easily buy and sell securities. They may look for long-term commitments from the people who invest in their funds, but they aren’t necessarily interested in the long term when they do their trading. Because of that, they tend to be more active in currency and debt than in stock. The currency markets offer the greatest liquidity, and government bonds are a close second. More liquidity makes for more opportunities to make money.
Most hedge funds move money in and out of markets quickly, using borrowed money to increase their commitments to different investments. If a fund manager sees a good opportunity, he’ll buy. If the situation changes, he’ll sell. Because they turn their investments over on short notice, hedge funds aren’t always beloved. In fact, many people in Asia blame hedge funds for the 1997–1998 currency crisis that damaged many economies there, even though the funds didn’t make policy, only profits.
Hedge funds that buy stock tend to look only at the largest of the emerging markets because they need to put a lot of money to work. Because many fund managers see higher profit potential from stocks in emerging markets than from stocks in developed markets, they invest in emerging markets wherever they believe they can acquire a good-sized position. That’s why, for example, you’re more likely to see hedge funds invest in Brazil than in Botswana.
Venture capital funds
Venture capital funds, which many high-net-worth investors invest in, provide financing to companies at the early stages of their existence. Because most new businesses fail, venture investing is risky. However, those businesses that succeed often succeed spectacularly, and investing early in a company like Google can make up for an awful lot of trips to bankruptcy court. The goal is to get a company to the point where it can make an initial public offering (the first time that a company sells shares of stock to the public) or be sold to a larger company.
Emerging markets have great opportunities for new businesses, and that makes them really appealing to venture capitalists. They don’t have to find the next Google; they can find something a lot simpler and still make money. However, emerging markets aren’t perfect for venture capital. In many countries, entrepreneurs would be happy with loans of just a few hundred or a few thousand dollars. They often don’t have a cohort of professional managers that venture capitalists typically hire, and the legal systems in emerging markets are rarely ready to accommodate the needs of a venture capital–funded start-up. If you’re considering venture capital in emerging markets, you need to assess the opportunity’s conditions and your own risk tolerance.
Expatriates are behind a lot of venture investments; successful immigrant executives in the United States, especially in the technology industry, often know of good start-ups in their home countries and work with the venture capitalists to arrange for the investments.
Private equity funds
Private equity funds provide capital to existing companies. They may help a company expand, they may help it avoid bankruptcy, or they may buy out the founder’s share of the business. They tend to be active in emerging markets because private equity has many of the advantages of venture capital with few of the headaches that go with starting up a business. A private equity firm can make money from an investment as a business grows, but it doesn’t have to find managers or provide a lot of operating advice.
The managers of these funds are usually comfortable with the logistics of running a business because many of them are retired corporate executives. That expertise is important, because in an emerging market, investors may be running a business for a long time.