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Maria Kozlokski, Principle Investment Officer, and Jean Laprevotte, Investment Officer, International Finance Corporation

Kozloski and Laprevotte on balancing socio-economic responsibilities with the need to generate returns, on finding quality managers in developing markets and on the importance of local knowledge in a management team.

The International Finance Corporation (IFC) is the private sector affiliate of the World Bank. The organisation was founded in 1956 to promote sustainable private sector investment in developing countries as a way to reduce poverty. The IFC makes direct long-term loans and equity investments as well as investing in funds in emerging markets throughout the world. Maria Kozloski is the head of the IFC’s private equity fund investment group and Jean Laprevotte is the investment officer responsible for Latin America.

What is the IFC’s mandate in terms of private equity?
Kozloski: ‘The World Bank was initially set up in the wake of World War II to help boost a global post war economy, but the organisation quickly became associated with promoting emerging markets. In the World Bank’s early years it became clear that while on the one hand it was necessary to provide support at a governmental level, a separate body was also needed to help support the private sector. So in 1956 a separate pool of capital was set aside and called the IFC.

‘In essence our mandate at the IFC is to provide support to private sector enterprises in emerging markets. The IFC invested approximately $4bn of financing to private sector enterprises in emerging markets in the fiscal year ending June 2003. The majority of our investments tend to be made directly, through long-term loans and equity, but a portion, the size of which will vary in any given year, is also invested through private equity funds.’

Laprevotte: ‘Equity represents about 20 or 21 per cent of our total portfolio. Loans represent 70 per cent and the rest is comprised of guarantees and risk management. Fund investments represent about 30 per cent of total equity commitments.’

What type of investments do you look for?
Kozloski: ‘Private sector development in our member countries is the most important factor for the IFC. We therefore select funds that we feel can add value at company level. This value addition may be achieved through hands-on management, past experience and track record, or perhaps a thorough knowledge of a certain country or region.

‘But although developmental issues are important to us, the IFC makes commercial investments. We are not a grant facility. We aim always to make attractive financial returns on each of our investments and we will not invest unless we think these are achievable. In the majority of cases we do not find it difficult to reconcile these two aims. If you have a strong experienced fund manager that can provide value addition at a company level then that obviously meets the IFC’s commercial return requirement and meets our developmental objectives as well.

‘In terms of an investment approach with regards geography, sector and stage, it is important to remember that emerging markets tend not to have the same depth of private equity industry that we are used to in Europe or the US. We invest in emerging markets throughout the world but it is difficult to be too specific beyond that point. For example very few of these markets actually support a venture community. There are exceptions in India, China and parts of Eastern Europe, but in general there isn’t any real stratification in the emerging market private equity industry. So rather than a specific focus, we are looking for experienced managers with a genuine understanding of the region in which they are operating, and we take it from there.’

How do you go about putting your portfolio together?
Laprevotte: ‘Right now the main chunk of our portfolio is in Asia where we have 37 per cent of our funds. We have 24 per cent in Latin America, 17 per cent in Europe and Central Asia and 14 per cent in sub-Saharan Africa. We have around three per cent in the Middle East and North Africa and then the remaining five per cent is invested in global emerging market funds. But this is not a fixed allocation and it is a constantly shifting model.’

Kozloski: ‘The IFC has a presence in all of our member countries, either directly or through the World Bank and we aim to have a high calibre network of investment professionals covering each of our major markets. We are able to use this breadth of expertise to formulate and adapt our allocation strategy according to the current situation. It is important that we know the regions that we are investing in ourselves, in order to seek out fund managers with similar expertise.’

How difficult is it to find quality fund managers in the areas that you are investing in?
Kozloski: ‘It’s very difficult. Emerging market private equity is still at a very basic stage of development. These markets haven’t had the time to produce the track record or experience that is generally associated with a quality manager. The level of maturity we can expect to find depends on the market. In Latin America, Asia and now increasingly Eastern Europe, we are beginning to find at least a pool of private equity managers that we can sort through. It’s much more difficult in North and sub-Saharan Africa. We see a lot of deals every year. I would say that we review at least 200 possibilities, of which we would actually invest in between eight and ten.’

How has emerging market private equity developed over the last few years?
Kozloski: ‘The past few years have been very difficult for emerging market private equity. Fundraising has been exceptionally hard everywhere over the last couple of years, and in emerging markets times have been particularly tough. There is a lot of consolidation going on and only the best funds will survive.’

Laprevotte: ‘As the global private equity market has continued to suffer, it has become increasingly difficult for emerging managers to raise investment capital abroad. And in many cases the local markets simply do not have an adequate institutional investor base. But we think that this is set to change as an increasing number of pension funds in emerging markets begin to look at alternative assets as part of their asset allocation.’

What type of managers do you invest with?
Kozloski: ‘We work with a cross section of large global funds and smaller country and regional specific funds. Very few of the larger players are currently involved in developing markets private equity, although we do work with firms such as Advent International, AIG, Barings and JP Morgan.

‘In larger markets such as India, China and Russia we tend to invest with country-specific firms. But we have found that you need to be a little careful with country funds because some countries just don’t have the scale to support a private equity fund. They simply do not have the volume of deal flow.’

How do you balance your socio-economic responsibilities with your need to generate returns?
Kozloski: ‘All of the funds in which we invest are required to comply with our environmental and social guidelines. Generally what we have found is that we need fund managers that can deliver a commercial return in order that we can meet our developmental objectives. We need to have fund mangers that can create value at a portfolio company level because if they don’t do that then we don’t meet our overall objectives.’

Laprevotte: ‘We don’t see returns and objectives as mutually exclusive. A fund that generates a good return will have a strong development impact because the portfolio company will continue to thrive whereas the portfolio companies of a fund that fails to generate returns will probably end up getting into trouble.’

Have you ever considered investing in more developed markets in order to generate the returns to reinvest in developing markets?
Laprevotte: ‘Our mandate is to invest in developing markets. We will only invest in a developed market in very specific situations. If a company is based in a developed market but has its main activities in a developing market then that might constitute a viable investment for us. You can have a technology company that will have most of its development work in India but that has its head quarters in the West, for example. But we wouldn’t invest in a developed market simply to generate returns in order to re-invest in developing markets.

‘In fact we have never needed to make those kinds of concessions. We’ve actually been profitable every year since our creation and we have been able to generate these returns in emerging markets. Of course there have been crises, but they tend not to happen in all markets at the same time. We are counter-cyclical so when there is a crisis we actually step up our activity in order to generate good returns in the future.’

What do you consider to be the biggest risks in the type of investing that you do?
Kozloski: ‘The biggest risk for emerging markets private equity is the difficulty in achieving exits. You don’t have the same type of liquidity in emerging markets as you do in Europe or the US. You don’t have the same depth in the traded market and you don’t have as developed strategic investors. This structural risk is compounded by an unsophisticated and immature private equity infrastructure, and that too presents a risk for an investor operating in emerging markets.’

Laprevotte: ‘It’s more difficult to access good management in emerging markets and it’s also more difficult to access debt. There tend to be longer holding periods because of the tough exit conditions which make it more difficult to get a good return. In addition, we are faced with macroeconomic risks, particularly devaluation. Obviously some markets have a higher level of political risk than others but that is normally factored into the entry price.’

What size of investment do you typically make?
Kozloski: ‘The size of investment we make varies considerably depending on the type of fund we are investing in. It can range anywhere from $5m to $50m, but most of our investments are in the $10m to $15m bracket.’

What do you look for in a fund manager?
Kozloski: ‘We are looking for fund managers that have a demonstrated ability to invest. Most of the things that we are looking for are actually the same things that you would look for in developed markets. But track records are often hard to come by in emerging markets. So for us it’s about whether the managers know about the investment process itself and also if they really understand the markets that they are involved in.’

Do you invest in first time funds?
Kozloski: ‘We do look at first time funds but we are very selective when we do so. You have to remember that in emerging markets you don’t have the same sorts of depths of private equity tradition and so first time managers can often be your only choice.’

What would put you off investing in a fund?
Kozloski: ‘We are put off when we don’t see a clear alignment of interests. We want fund managers that are driven by capital gains and not fees.’
            
What advice would you give a new investor in private equity?
Kozloski: ‘The advice I would give to any investor in private equity is to understand the asset class and to do your due diligence. I am often surprised at just how limited the knowledge of some investors is. We spend a lot of time trying to understand our fund managers and their transaction approach so that we are as familiar as we can be with the investment that we are getting into. After all, these are lock-up investments. If you make the wrong decision it can have a severe impact on your long-term portfolio.

‘Our fund department mandate is to provide capital to private equity firms in emerging markets. But we also do a lot of work to help to professionalise the industry. We are currently working with fund managers on reporting standards, and on valuation guidelines. We also have what we call the GP tool kit, which is designed to assist private equity firms as they establish themselves in the market. It includes everything from advice on putting together a PPM to how to approach and deal with investors. Equally, I would also encourage investors to really understand these areas. Investors should understand how the private equity funds they invest in are governed, who the manager is, what their strategy is, and how successful their deals have really been. It is important for investors to be more active in knowing what is going in their portfolio.’

What do you consider to be the biggest issue in the industry at the moment?
Kozloski: ‘I think that there is a lot to be done to improve the level of transparency in the market. I also think that it’s important that managers are made to recognise that what they are doing is managing third-party capital and that they are therefore fully accountable to their investors. Managers need to be given the incentive to deliver.’

What changes do you expect to take place in the future?
Laprevotte: ‘I think that emerging markets are in the same place that the US and Europe were a decade and a half ago. The most advanced emerging markets are just reaching the second or third generation of funds. People are starting to build a track record, industry relations are forming and information is starting to become available through benchmarking initiatives. The industry is poised to develop.

‘Of course, emerging market private equity will go through its ups and downs just as the US industry did in the beginning. But the trend towards a greater professionalisation of fund management has already been set. Importantly, we are starting to have some success stories that will encourage entrepreneurs to try the private equity route.

‘You can draw a clear parallel between the development of the private equity industry in more developed markets and the changes that are taking place in emerging markets at the moment. The developing markets are naturally more inefficient than developed markets but that actually means there are more opportunities to make good returns if you pick the right managers. There is no reason why these markets can’t catch up with Europe and the US, given time.’

This is an edited version of an in-depth interview. For details on how to obtain the full version of this and other AltAssets Institutional Investor Profiles, please click here.

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