Exporting capitalism

At a recent private equity conference on emerging markets, both the perils and potential of investing in the developed world were brought into clear focus. By Paul Fruchbom

Three years after his death, Ronald Reagan is making something of a comeback. Last month, The Reagan Diaries, a compendium of the former US president's private journals, reached number four on Amazon's best seller list. An excerpt from the book even appeared in the July & August issue of Vanity Fair, which featured Reagan-era action star Bruce Willis on the cover. And a few weeks before the book's release, the 41st president not only served as the de facto host of a Republican presidential debate—it was held at the Ronald Reagan Presidential Library in Simi Valley, California—but also as its guiding spirit. In an effort to channel Reagan's legendary optimism, the candidates specifically mentioned his name 19 times.

Last month, however, the upbeat spirit of President Reagan was perhaps best reflected not in California, but in Washington DC, where another building named after the former commander-in-chief—the Ronald Reagan Building and International Trade Center—played host to another equally raucous affair: IFC's 9th annual global private equity conference focused on emerging markets. And if you thought presidential longshots like Tom Tancredo were optimistic, then you didn't meet some of the investors trying to raise capital at the event. West African real estate, anyone?

Fund managers looking to raise an emerging market vehicle may want to avoid wowing potential LPs with optimistic stories about vast, untapped markets and unlimited potential. Most people get all that. Instead, focus on hard-nosed realism and straightforward communication—then, convince your investors to get on a plane with you.

Yet for all the positive assessments delivered about the state of the developing world, there are obviously huge challenges in prudently deploying capital in these markets, challenges that were brought into focus during a Friday morning panel on real estate investing.

Take Russia, for example. The former Communist state may have embraced capitalism—due, in some small part, to Reagan himself—but that doesn't mean the new capitalists play by Western rules. Jon Hodnett, a Moscow-based director with JER Partners, told the crowd that ten of his deals had fallen apart because a background check on a seller or a local partner turned up some unsavory details.

Another panelist, Phil Fitzgerald of Paladin Realty Investors, which focuses primarily in Latin America, related a similar story about working in Brazil. One of Paladin's operating partners recently sued the firm after they had been removed from a project. And the reason they filed suit was that they hadn't been given enough notice for the meeting in which they were actually fired. “Never mind that they still showed up to the meeting,” Fitzgerald said.

As these anecdotes (and many others) make clear, the biggest challenge in emerging markets is finding the right local partner. Yet as the panelists made clear, it is also critical to have the right limited partners as well. Hodnett noted that JER had to reach out to a whole new group of investors in order to raise their Russian-focused property vehicle. Many existing LPs simply did not feel comfortable investing in the former Soviet Union.

The reason why, according to the panelists, is that a disconnect still remains between perception and reality in many emerging markets. Russia, for example, is viewed as a hotbed of corruption, but Hodnett noted that Germany, which is generally perceived to be clean, is equally if not more corrupt. When it comes to South America, Fitzgerald said that popular perceptions of violence and danger are overblown—he actually feels safer walking around Cartagena than Mexico City.

The key to overcoming those perceptions—and, by extension, increasing the liquidity and transparency in these markets— is first-hand experience. Any potential investor who actually traveled to Moscow, Hodnett said, eventually invested in JER's fund.

From that perspective, then, fund managers looking to raise an emerging market vehicle may want to avoid wowing potential LPs with optimistic stories about vast, untapped markets and unlimited potential. Most people get all that. Instead, focus on hard-nosed realism and straightforward communication— then, convince your investors to get on a plane with you.

In other words, borrow a page from Ronald Reagan. Yes, he was an optimist, but even more than that, The Great Communicator knew how to get his message across.

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