Emerging markets (EM) will capture an even greater share of investor allocations to private equity (PE) as limited partners (LPs) aggressively seek exposure to high-growth markets such as India, China and Brazil, a new global survey has found. At least half of the surveyed LPs that invest in PE firms expect returns of over 16% over the next three-five years in EMs. Nearly a quarter anticipate returns of over 21%. A typical EM investor will have 16-20% of its total PE allocation targeting emerging markets in 2013, compared with 11-15% now, according to the latest Emerging Markets Private Equity Association (EMPEA)/Coller Capital Emerging Markets Private Equity Survey, based on a review of 156 PE investors in North America, Europe and the Asia-Pacific.

"Institutional investors facing escalating liabilities within the next 5-10 years find growth opportunities in emerging markets very compelling," said Sarah Alexander, president and chief executive, EMPEA. "While China and India still top LP wish lists, investors are also shifting their gazes to the less penetrated markets of Latin America and Southeast Asia." Brazil is now seen as the most attractive market for deal making in the near term for general partners (GPs), pushing China into the second place. Brazil will also gain the largest influx of new investors as 14% of LPs plan to begin investing there.

The nascent Asian PE markets are now perceived to be as attractive as China, and will see increased investment from both current and new investors, the report said. Further, 73% of LPs expect 2011-vintage emerging market PE funds to generate higher returns than developed markets funds of the same period. Almost all investors attributed this expected outperformance to faster growth in emerging market economies. Returns of as much as 16% are achievable in the right investment environment if GPs can get their portfolio companies to scale up fast and in line with a given economic growth, said Erwin Roex, partner, Coller Capital. "Expecting returns of over 20%, I find, is very aggressive.

Such returns would mean consistent performance over a very long period of time. Specific GPs can achieve that but to expect entire PE portfolios to give 21% returns may be a bit wishful," Roex said, adding that when it comes to backing GPs in India, LPs would bet on existing ones and local teams would be of interest. According to the report, while competition is increasing in emerging PE markets, it tends to be concentrated within a handful of sectors or a particular tier of the market where deals are large enough to attract global funds. "Investors recognize there are still plenty of opportunities for skilled managers to supply value-added capital and to create returns for LPs," said Roex. While LPs are comparatively bullish on PE returns in EMs, investors' return expectations for an individual PE market vary, depending on whether they have exposure to that market.

According to the report, environmental, social and governance considerations materially impact GP selection for two-thirds of emerging market PE investors. As many as 22% of them have investment mandates directly restricted by these issues. "The fact that such a large number of LPs are factoring these considerations into their manager selection decisions signals the link increasingly being drawn between manager focus on these issues at the portfolio company level and the ability to create value and generate stronger returns," Alexander said. LPs said political risk was a major deterrent to investing in Russia, West Asia, North Africa and sub-Saharan Africa. High entry valuations are the biggest hurdle for new investors in India, China and Brazil, they said.

Deals India, published jointly by Mint, Dow Jones Newswires and The Wall Street Journal, is a one-stop destination for investment professionals following deal flow, deals news, private equity and venture-capital activity in India.

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