U.S.

Institutional Investors Interest in Emerging Market Private Equity

10 August 2006

This report was written by E. Brooke Whitaker T06 under the supervision of Adjunct Associate Professor Fred Wainwright and Professor Colin C. Blaydon of the Tuck School of Business at Dartmouth College. It was written as a basis for class discussion and not to illustrate effective or ineffective management practices. Copyright 2006 Trustees of Dartmouth College. All rights reserved.

IMPORTANT NOTICE ................................................................................................................................ 3 1. EXECUTIVE SUMMARY .................................................................................................................. 4 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 2. OBJECTIVE AND METHODOLOGY ................................................................................................ 4 EMPE PORTFOLIO ALLOCATION ................................................................................................ 4 EMERGING MARKET PUBLIC EQUITIES ....................................................................................... 4 LP STRATEGIES FOR EMPE....................................................................................................... 5 CONSTRAINTS ON INCREASED INVESTMENT IN EMPE .............................................................. 5 DEGREE AND SCOPE OF GP DUE DILIGENCE ............................................................................ 6 IMPORTANCE OF DFI INVESTMENT ............................................................................................. 6 REGIONS AND COUNTRIES OF INTEREST .................................................................................... 6 LOCAL INSTITUTIONAL INVESTMENT ........................................................................................... 6 RETURN EXPECTATIONS ............................................................................................................. 6

OBJECTIVE AND METHODOLOGY ............................................................................................. 8 2.1 2.2 OBJECTIVE................................................................................................................................... 8 METHODOLOGY ........................................................................................................................... 8

3. 4. 5. 6. 7. 8. 9. 10. 11.

EMPE PORTFOLIO ALLOCATION................................................................................................ 9 EMERGING MARKET PUBLIC EQUITIES ................................................................................. 10 LP STRATEGIES FOR EMPE ....................................................................................................... 11 CONSTRAINTS ON INCREASED INVESTMENT IN EMPE .................................................... 12 DEGREE AND SCOPE OF GP DUE DILIGENCE ..................................................................... 14 IMPORTANCE OF DFI INVESTMENT......................................................................................... 14 REGIONS AND COUNTRIES OF INTEREST ............................................................................ 15 LOCAL INSTITUTIONAL INVESTMENT................................................................................ 16 RETURN EXPECTATIONS ....................................................................................................... 16

APPENDIX 1. SOURCES ....................................................................................................................... 17 APPENDIX 2. QUESTIONNAIRE.......................................................................................................... 22 ANNEX ........................................................................................................................................................ 23 ABOUT THE AUTHOR................................................................................................................................ 23 CENTER FOR PRIVATE EQUITY AT THE TUCK SCHOOL OF BUSINESS AT DARTMOUTH ......................... 23

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U.S. Institutional Investors Interest in Emerging Market Private Equity

Important Notice
As a research fellow at the Centre for Private Equity at the Tuck School of Business at Dartmouth during 2005/2006, the author interviewed investment managers at 20 U.S.based institutions in an effort to understand their views on emerging markets private equity. Each interview lasted between 15 and 70 minutes. Although a number of the investment officers that were surveyed answered all questions in great detail and offered additional insight and thought, a few investment officers were unable to answer every question due to their time constraints. The survey was conducted with the understanding that each institution and the investment officer interviewed would remain anonymous. To provide an additional layer of anonymity, the surveys findings have been demarcated into broad categories based on total assets under management. The term emerging market was defined for the purpose of this survey as all countries in Central and South America, the Middle East, Central and Eastern Europe, Africa, and Asia (except Japan and Australia). The general partners of private equity funds are hereafter known as GPs. Institutional investors are hereafter collectively known as limited partners or LPs or simply as institutional investors. Development finance institutions (DFI) are those institutions such as the International Finance Corporation (IFC), the European Bank for Reconstruction and Development (EBRD), the Asian Development Bank (ADB), etc. The author and the Centre for Private Equity at the Tuck School of Business at Dartmouth wish to thank the investment officers who participated in this survey for their time and insight. We also wish to thank the many GPs of private equity funds based in the UK, Kenya, South Africa, Indonesia, Thailand, UAE, Vietnam and Singapore, the development finance institutions, and the Emerging Markets Private Equity Association. A number of attorneys in Singapore, Indonesia, and South Africa who provide transaction support services to private equity firms also contributed generously to this study.

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U.S. Institutional Investors Interest in Emerging Market Private Equity

1.
1.1

Executive Summary
Objective and Methodology

The objective of the survey was to understand how US-based institutional investors view emerging markets private equity (EMPE), and to identify any major trends, strategies, and perceptions therein. Using Thomsons VentureXpert1 online limited partner directory, 20 institutional investors who had a cumulative total of $994 billion in total assets under management were contacted during March, April, and May 2006 and were asked a series of questions (See Appendix 2. Questionnaire) in confidential telephone interviews that lasted between 15 and 70 minutes each. Type and Number of Institutional Investors
Type Banks & Financial Corps. Consultants/Gatekeepers/Fund of Funds Educational Endowments Foundations Government Corporate Pension Funds Insurance Companies Total Population 142 63 284 113 153 910 158 1,823 Number Contacted 1 3 4 3 3 3 3 20

1.2

EMPE Portfolio Allocation

Although there were a few outliers, all LPs except for insurance companies and consultants/gatekeepers/fund of funds expected to invest between 10 and 15 percent of their total portfolio in private equity, and to have between 10 to 15 percent of their total private equity investments be comprised of EMPE.

1.3

Emerging Market Public Equities

With the exception of the EMPE consultants/gatekeepers/fund of funds, all LPs interviewed held emerging market public equities within their investment portfolios and stated that they were invested in individual companies rather than in emerging market index or mutual funds. Six LPs viewed emerging markets public equities as the only emerging market investment that they would currently make based on the fact that their investments in emerging markets public equities have performed well historically whereas investments in EMPE have, historically, performed poorly. These same LPs,

http://vx.thomsonib.com/NASApp/VxComponent/VXMain.jsp

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U.S. Institutional Investors Interest in Emerging Market Private Equity however, stated that they would reconsider investing in EMPE once returns started to improve.

1.4

LP Strategies for EMPE

While all LPs interviewed were aware of EMPEs poor performance in recent years and six LPs stated that they would want to see EMPE returns improve for a period of time before they would consider to invest or to increase their investments in EMPE, of the remaining 11 LPs (except for insurance companies who were not considering investing in EMPE), all believed that it is possible to generate commercial returns in EMPE. They all also recognized that it would be best if they had internal personnel with knowledge of the cultures, languages and business practices of different emerging markets who would identify, evaluate and monitor the institutions EMPE investments rather than to have someone without this experience performing this function. The size of the LP and its number of internal investment personnel, however, greatly influenced each LPs EMPE strategy. For example, two of the Large LPs stated that in order to increase their investments in EMPE, they would need dedicated resources to identify, evaluate and monitor their EMPE investments. These Large LPs and some of the Medium LPs with investments in EMPE therefore focused only on two or three emerging market countries and divided the workload among their investment staff. The Medium and Small LPs that lacked the internal staff to identify, evaluate and monitor EMPE investments effectively or to do so on a larger scale (i.e. an increase of two or more investments) were either making select investments in EMPE with GPs with whom they already had relationships, were investing through an EMPE fund of funds, or were using a gatekeeper or consultant to identify EMPE investment opportunities for them. Only two Large LPs had made investments in EMPE fund of funds while all other Large LPs and a many Medium LPs found this strategy problematic due to a perceived lack of alignment between the fund of funds interests and that of the investing LP. The EMPE fund of funds had the most long term view of EMPE in terms of having experienced investment personnel with extensive emerging market experience and creating a contact network with many emerging GPs throughout a number of emerging markets with the goal of developing the next generation of GPs in emerging markets.

1.5

Constraints on Increased Investment in EMPE

In addition to the lack of internal investment personnel, other constraints on investment or increased investment in EMPE were: poor historical returns for EMPE; few qualified

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U.S. Institutional Investors Interest in Emerging Market Private Equity GPs in emerging markets2; lack of supporting institutions3; and the relative small size of some EMPE funds (affected mostly Large LPs).

1.6

Degree and Scope of GP Due Diligence

The degree and scope of due diligence that Large and Medium LPs would perform on EMPE investment opportunities were generally very comprehensive and detailed. A significant majority of Large and Medium LPs stated that they would perform the same level of due diligence on EMPE GPs as they would on developed market GPs, but these LPs recognized that the general lack of experienced GPs in EMPE required the relaxation of certain criteria (e.g. number of years the GPs have worked together and have produced top quartile returns). The level and degree of due diligence that Small LPs would conduct on GPs was generally more qualitative and much less investigatory than the level and degree of due diligence that Medium & Large LPs performed. When asked if they applied the same level of due diligence for GPs within EMPE, they stated that they would apply more stringent criteria than they would to GPs within developed markets.

1.7

Importance of DFI Investment

Large and Medium LPs views on development finance institution4 (DFI) investment capital ranged from neutral to negative when considering an EMPE investment opportunity, while all Small LPs view DFI investment as a positive.

1.8

Regions and Countries of Interest

There was no clear consensus among the LPs regarding their interest in investing in regional versus country-specific funds. However, China, India, Brazil, Israel and South Africa were of particular interest to a number of LPs.

1.9

Local Institutional Investment

All LPs viewed local institutional investment as a positive sign, while a majority stated that they would view a very large GP investment in the fund as the most positive sign.

1.10 Return Expectations

It is interesting to note that an overwhelming number of those LPs who followed a top-down approach to EMPE investing stated that the poor state of supporting institutions in emerging markets was a key constraint, while those LPs that followed a bottom-up approach to EMPE investing stated that the limited number of qualified GPs in emerging markets was a key constraint. 3 Ibid. 4 For example, International Finance Corporation (IFC), European Bank for Reconstruction and Development (EBRD), Asian Development Bank (ADB), etc.

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U.S. Institutional Investors Interest in Emerging Market Private Equity LPs across all categories generally believed that investments in EMPE should generate a return greater than 25 percent.

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U.S. Institutional Investors Interest in Emerging Market Private Equity

2.
2.1

Objective and Methodology

Objective

The objectives of the survey were to understand how US-based institutional investors view emerging markets private equity (EMPE), and to identify any major trends, strategies, and perceptions therein. Specifically, the objective of the survey was to understand the following: The current and future percentage of their portfolios that LPs allocate to EMPE. The strategy that LPs have for EMPE. The criteria that LPs utilize in evaluating GPs in EMPE and the degree to which this criteria is applied to GPs in EMPE vis a vis GPs in developed markets such as in the US or UK. Which emerging market regions and countries are popular or unpopular, and why are they viewed as such. The importance of development finance institution5 (DFI) investment capital in helping attract U.S. based institutional investment capital. The major constraints or issues that prevent or hinder LPs from investing or increasing their investment in EMPE.

2.2

Methodology

Using Thomsons VentureXpert6 online limited partner directory, a population of 1,823 institutional investors representing a cross-section of different types7 of institutional investors was identified. Of these, 20 institutional investors who had a cumulative total of $994 billion in total assets under management were contacted during March, April and May 2006 and were asked a series of questions (See Appendix 2 Questionnaire) in telephone interviews that lasted between 15 and 70 minutes each. Although a number of the investment officers surveyed answered all questions in great detail and offered additional insight and thought, a few investment officers were unable to answer every question due to their time constraints. The survey was conducted with the understanding that each institution and the investment officer interviewed would remain anonymous. To provide an additional layer of anonymity, the surveys findings have been demarcated into broad categories based on total assets under management. Large LPs were classified as those institutions with more than $5 billion in total assets under management; Medium LPs were classified as those institutions whose total assets under management were less than $5 billion but

For example, International Finance Corporation (IFC), European Bank for Reconstruction and Development (EBRD), Asian Development Bank (ADB), etc. 6 http://vx.thomsonib.com/NASApp/VxComponent/VXMain.jsp 7 Bank & financial corporations, consultants/gatekeepers/fund of funds, educational endowments, foundations, government, corporate pension funds, and insurance companies.

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U.S. Institutional Investors Interest in Emerging Market Private Equity greater than $2 billion, while Small LPs were classified as those institutions with less than $2 billion in total assets under management. Because there are many different types of institutional investors, for the purpose of this survey, the institutional investors were classified into the following types of institutions: corporate pension funds, educational endowments, foundations, insurance companies, banks and financial corporations, and consultants/gatekeepers/fund of funds. These different types of institutional investors are hereafter collectively known as limited partners or LPs or simply as institutional investors. In choosing which institutional investors to contact within each type of institution, an effort was made to contact at least one Small, one Medium and one Large LP for each type of investor. Due to the difficulty in successfully reaching the investment officers of any particular institution and the time constraint that the survey was conducted under, some LPs within each type of institution were similar in size (e.g. two Large LPs and one Medium LP rather than one Small, one Medium and one Large LP). Type and Number of Institutional Investors
Type Banks & Financial Corps. Consultants/Gatekeepers/Fund of Funds Educational Endowments Foundations Government Corporate Pension Funds Insurance Companies Total Population 142 63 284 113 153 910 158 1,823 Number Contacted 1 3 4 3 3 3 3 20

3.

EMPE Portfolio Allocation

Although there were a few outliers, all LPs except for insurance companies and consultants/gatekeepers/fund of funds expected to invest between 10 and 15 percent of their total portfolio in private equity, and to have between 10 to 15 percent of their total private equity investments be comprised of EMPE. One Small LP stated, however, that they wished to have 25 percent of their total private equity investments be comprised of EMPE within the next five years. By contrast, insurance companies had only one percent of their total portfolios allocated to private equity, and their investments in EMPE were practically nonexistent, due to regulatory constraints. Fund of funds had 100 percent of their funds invested in EMPE.

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U.S. Institutional Investors Interest in Emerging Market Private Equity

4.

Emerging Market Public Equities

With the exception of the EMPE consultants/gatekeepers/fund of funds, all LPs interviewed held emerging market public equities within their investment portfolios, and stated that they were invested directly in individual companies rather than in emerging market index or mutual funds. Six LPs viewed emerging markets public equities as the only emerging market investment that they would currently make, an assessment they made based on the fact that their investments in emerging markets public equities have performed well historically, in contrast to investments in EMPE, which have performed poorly historically. These LPs also stated that they preferred emerging market public equities because they provided greater liquidity than did EMPE, diversification for their portfolios, and companies with better corporate governance structures in which to invest than did private companies in emerging markets. Furthermore, these LPs mentioned that the emerging market countries in which they had invested possess enhanced capital markets and better supporting institutions8, which made investing in emerging market public equities a better investment than did EMPE. These LPs also stated that they would reconsider investing in EMPE once returns start to improve. When questioned further about whether they would invest in EMPE in countries with enhanced capital markets and supporting structures, a number of these LPs added to the reasons given above that there were inherent difficulties in investing in EMPE such as the language and cultural differences. As one Medium LP stated, they needed to have someone get on the ground who understood the place [country] to evaluate the GPs and the opportunity, which the quoted investment officers institution could not do with its current staffing. One other Medium LP mentioned that although returns in EMPE had been quite low historically and that past performance was not an indicator of future performance, this investment officers other chief concern with EMPE was the poor level of corporate governance at the company level in emerging markets. This Medium LP stated that, corporate governance in companies that are publicly listed on exchanges in emerging markets is far better than it is in the private companies in these countries [emerging markets]. The author recognized that, in general, private companies in emerging markets do have poor corporate governance, but the author replied that GPs in emerging markets had an unusually great opportunity and fiduciary responsibility to improve the corporate governance structures in the companies in which they invest and could do so more effectively than could the shareholders in public equities, creating tremendous value in the process. In response, the investment officer stated that his institution had not received a private placement memorandum for an EMPE fund from a qualified GP, in which

Independent judiciary, developed professional services industry such as accounting, tax, business consulting, and legal advisory services, developed banking sector, enhanced capital markets, etc.

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U.S. Institutional Investors Interest in Emerging Market Private Equity improving the corporate governance in the portfolio companies in which the GP would invest was core to the investment strategy.

5.

LP Strategies for EMPE

While all LPs interviewed were aware of EMPEs poor performance in recent years and six LPs stated that they would want to see EMPE returns improve for a period of time before they would consider to invest or to increase their investments in EMPE, of the remaining 11 LPs (except for insurance companies who were not considering investing in EMPE), all believed that it is possible to generate commercial returns in EMPE. They all also recognized that it would be best if they had internal personnel with knowledge of the cultures, languages and business practices of different emerging markets who would identify, evaluate and monitor the institutions EMPE investments rather than to have someone without this experience performing this function. The size of the LP and its number of internal investment personnel, however, greatly influenced each LPs EMPE strategy. For example, two of the Large LPs whose investment performances are highly regarded in the industry and are active investors in EMPE, mentioned the importance of conducting on the ground/in-country reference checks on emerging market GPs to confirm not only their character and standing within the local business communities, but also their ability to unlock value from their contact and information networks. These Large LPs stated that in order to increase their investments in EMPE, they would need dedicated resources to identify, evaluate and monitor their EMPE investments. These Large LPs and some of the Medium LPs with investments in EMPE therefore focused only on two or three emerging market countries and divided the workload among their investment staff. The Medium and Small LPs that believed that it is possible to generate returns in EMPE but stated that they lacked the internal staff to identify, evaluate and monitor EMPE investments effectively or to do so on a larger scale (i.e. an increase of two or more investments) were either making select investments in EMPE with GPs with whom they already had relationships, were investing through an EMPE fund of funds, or were using a gatekeeper or consultant to identify EMPE investment opportunities for them. Of the Medium and Small LPs investing in EMPE fund of funds, they viewed these investments as a way in which they could establish relationships with emerging market GPs in order to facilitate direct investment in specific GPs in the future. Only two Large LPs had made investments in EMPE fund of funds while all other Large LPs and a many Medium LPs found this strategy problematic. Specifically, these LPs felt that fund of fund managers stringency in due diligence on emerging market GPs would not match their own standards, because they believed that fund of fund managers were not return driven, thereby creating a lack of alignment between the fund of funds

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U.S. Institutional Investors Interest in Emerging Market Private Equity interests and that of the investing LP. As a result, these LPs stated that they wouldnt even consider investing in an EMPE fund of funds. The investment officers from these 11 institutions made a number of notable comments during their interview concerning the need for experienced internal investment staff with emerging market expertise that would be responsible for identifying, evaluating and monitoring EMPE investments: We just cant deal with those different cultures. We dont have expertise in these markets. The language and cultural, not to mention the accounting differences, are very difficult to deal with. There is a lack of good information on GPs in emerging markets. We need someone who can confirm the credibility of GPs on the ground in these countries. It [EMPE] is difficult to do right unless you get on the ground and do your own due diligence. No way am I going to leave that to a consultant to do. I would have no idea how to go about evaluating an opportunity in Indonesia or an opportunity in some of those other countries. We dont have anyone dedicated to EMPE but we have an in-house generalist with an MBA who monitors our [EMPE] investments, but he doesnt speak the language or understands the culture in these countries for company portfolio calls. Although a large majority of these 11 LPs stated a desire to supplement their current internal investment staff with additional personnel, only three of them had actually begun to develop an internal emerging market resource: one Large LP at the time of the survey had a staff member dedicated to EMPE while one other Large LP had one senior analyst spending approximately 60 percent of his time on EMPE. Another Large LP at the time of the survey was in the process of hiring a graduate from a top-tier MBA program to be dedicated to EMPE. (Note: By June 2006, this Large LP had hired this individual.) These LPs thus seemed dedicated to develop or acquire the requisite internal skills to identify, evaluate and monitor EMPE investments effectively. They also all stated that they were developing relationships with a number of GPs with whom they could invest over the long term, and were interested in identifying opportunities in other countries. The EMPE fund of funds had the most long term view of EMPE in terms of having experienced investment personnel with extensive emerging market experience and creating a contact network with many emerging GPs throughout a number of emerging markets with the goal of developing the next generation of GPs in emerging markets.

6.

Constraints on Increased Investment in EMPE

In addition to the lack of internal investment personnel, other constraints on investment or increased investment in EMPE were poor historical returns for EMPE; few qualified

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U.S. Institutional Investors Interest in Emerging Market Private Equity GPs in emerging markets9; lack of supporting institutions10; and the relatively small size of some EMPE funds (affected mostly Large LPs). The poor historical performance of EMPE has detracted a number of investment officers from EMPE and has made it a difficult sell for investment officers seeking to make to their respective investment boards. When the author mentioned to one Medium LP that Cambridge Associates Emerging Markets Private Equity Index noted a 22.1 percent return for the year ending 30 June 200511, this Medium LP stated that we need to see returns improve for a few years in a row before his institution would invest or increase its investments in EMPE. One LP stated that emerging markets private equity needs a high profile champion to get the word out that EMPE is beginning to produce commercial returns. Eight of the LPs, particularly the Large and Medium LPs, stated that the lack of experienced GPs in EMPE was also a key constraint in investing or increasing investment in EMPE. These LPs mentioned that few GPs had the experience or track record of providing top quartile returns for their investors and as a result, would frequently have to relax their criteria or standard for certain GPs. The Large LPs and Medium LPs who were intent on tracking the industry and on developing or acquiring internal skills to identify, evaluate and monitor EMPE investments on a larger scale, were currently monitoring a few emerging GPs in a few emerging markets. A number of the LPs also mentioned that few emerging market countries lacked the supporting institutions (e.g. developed capital markets, independent judiciary, etc.), which not only hindered their ability to increase investments in EMPE, but it also made confirming the emerging market GPs ability to operate and create value in these difficult markets all the more important. A majority of the Small LPs didnt raise these issues as constraints. Rather, these Small LPs stated that their internal human resource constraint was their greatest hindrance in investing or increasing investment in EMPE. One Large LP stated that his institution needed to deploy larger quantities of capital in order to move the return needle than did smaller-sized LPs. That, when combined with the fact that a number of EMPE funds are small (i.e. $100 million to $300 million) and internal policy constraints that prohibit an LP from investing more than a specified percentage of the total funds value, there are fewer opportunities to invest large sums of capital in EMPE than in developed markets such as the US or UK for Large LPs.

It is interesting to note that an overwhelming number of those LPs who followed a top-down approach to EMPE investing stated that the poor state of supporting institutions in emerging markets was a key constraint, while those LPs that followed a bottom-up approach to EMPE investing stated that the limited number of qualified GPs in emerging markets was a key constraint. 10 Ibid. 11 http://www.empea.net/docs/newsletters/Emerging%20Markets%20PE%20Returns%20Improving.pdf

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U.S. Institutional Investors Interest in Emerging Market Private Equity

7.

Degree and Scope of GP Due Diligence

The degree and scope of due diligence that Large and Medium LPs would perform on EMPE investment opportunities were generally very comprehensive and detailed. For instance, Large & Medium LPs conduct on-site interviews with members of the general partnership and team; review investment memoranda, portfolio company cash flow, and valuation assumptions; perform independent background checks on the GPs; and conduct interviews with portfolio company management. Two Large LPs mentioned that they even liked to conduct independent background checks on the GPs and sought to confirm the network and contacts that the GPs would use to generate deal flow. One of these Large LPs wanted to make certain that the GP had an unfair advantage in their respective market compared to other GPs in that market, which could only be done by being there, speaking with people and understanding the market and the opportunity. A significant majority of Large and Medium LPs stated that they would perform the same level of due diligence on EMPE GPs as they would on developed market GPs, but these LPs recognized that the general lack of experienced GPs in EMPE required the relaxation of certain criteria (e.g. number of years the GPs have worked together and have produced top quartile returns); if the LPs applied the same level of criteria to GPs in EMPE as they did to GPs in developed markets, no EMPE GP would ever meet our criteria. Furthermore, one Medium LP stated there is a lack of good information on GPs in emerging markets and that we need someone who can confirm the credibility of GPs in these countries. The level and degree of due diligence that Small LPs would conduct on GPs was generally more qualitative and much less investigatory than the level and degree of due diligence that Medium & Large LPs performed. For example, of the Small LPs surveyed, none mentioned such actions as reviewing investment memoranda or cash flow statements or valuation assumptions. Rather they looked for the alignment of interests, experience, checked references and looked for a unique investment thesis. When asked if they applied the same level of due diligence for GPs within EMPE, they stated that they would apply more stringent criteria than they would to GPs within developed markets.

8.

Importance of DFI Investment

Large and Medium LPs views on development finance institution12 (DFI) investment capital ranged from neutral to negative when considering an EMPE investment opportunity, while all Small LPs view DFI investment as a positive.

12

For example, International Finance Corporation (IFC), European Bank for Reconstruction and Development (EBRD), Asian Development Bank (ADB), etc.

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U.S. Institutional Investors Interest in Emerging Market Private Equity Those LPs that believed DFI investment was a negative held the view that if the GPs were truly capable and likely to generate commercial returns, those GPs would be able to raise their funds totally with institutional capital and would not need DFI investment capital. Therefore, the fact that a DFI had invested in a fund raised red flags for this investment officer. One other Large LP stated specifically that the different DFIs investment officers interests were not similarly aligned with those of an institutional investor because this particular investment officer was remunerated based on his ability to meet or exceed a benchmark index such as Cambridge Associates Private Equity Index, whereas the DFI investment officers remuneration was most likely not benchmarked to a similar performance index. One other Large LP qualified his view by stating that they would view DFI investment as a no go if the DFI constrained the GP from making certain types of investments or if the GP had any type of development focus. The remainder of Large LPs held neutral views of DFI investment; as these Large LPs stated that each had its own standards, policies and due diligence procedures for evaluating GPs and could make an investment decision independently of DFI investment in a GP. Medium LPs generally held neutral views of DFI investment in GPs as these LPs also held their own standards, policies and due diligence procedures for evaluating GPs and would make an investment decision independent of DFI investment in a GP. Small LPs all held positive views of DFI investment in GPs. A majority of the Small LPs believed the DFI provided a stamp of approval for the GP and, thus, they were more likely to invest in that GP.

9.

Regions and Countries of Interest

There was no consensus among the LPs regarding their interest to invest in regional versus country-specific funds. Due to time constraints, the investment officers were unable to discuss in detail what made specific countries attractive for their investment capital. However, the investment officers made the following comments: Large LP: would only invest in country funds on a deal by deal basis. This LP also stated that they liked India and Russia but not China because of a lack of rule of law and Brazil due to poor fundamentals. Small LP: had no specific strategy but liked regional funds and would consider Africa, Central Europe and Asia. Large LP: liked India and China for venture capital investing only. Large LP: would only invest in country specific funds because regional funds just dont work.

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U.S. Institutional Investors Interest in Emerging Market Private Equity Large LP: liked regions and country specific funds but mostly invested in EMPE fund of funds. Medium LP: liked emerging Europe as a regional play. Small LP: was very specific that they wanted to make regional plays in Asia and Central Europe only. Large LP: China only. Medium LP: Asia only on a country-by-country basis. Medium LP: had a particular interest and success in Israel with venture capital.

10. Local Institutional Investment

All LPs viewed local institutional investment as a positive sign but a few Large LPs recognized that most of the opportunities that they would be interested in pursuing would be of such high value that they wouldnt expect local institutions to have the requisite capital to be able to participate in the first instance. All LPs agreed that they would view a very large GP investment in the fund more positively than they would view local institutional investment.

11. Return Expectations

LPs across all categories generally believed that investments in EMPE should generate a return greater than 25 percent.

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U.S. Institutional Investors Interest in Emerging Market Private Equity

Appendix 1. Sources
Printed Material Albert, Kevin. The Albert Matrix Private Equity International. November 2005 Andersen, Jenny. After Doing Its Homework, a College Puts Its Money into Hedge Funds The New York Times. 12 May 2006 Arnold, David J. and Quelch, John A. New Strategies in Emerging Markets. MIT Sloan Management Review. Fall 1998 Asset Alternatives. Private Equity Partnership Terms and Conditions, Second Edition Asset Alternatives Bartlett, Joseph W. Do Emerging Economies Have the Right Stuff Private Equity International. September 2002 Bartlett, Joseph W. Private Equity in Emerging Markets Private Equity International. July/August 2002 Bremmer, Ian. Managing Risks in an Unstable World Harvard Business Review. June 2005 Drucker, Peter F. Reckoning with the Pension Fund Revolution Harvard Business Review. March-April 1991 Emerging Markets Private Equity Association. "EMPEA Advisor David Rubenstein Shares His Views on Emerging Markets" Emerging Market Private Equity Association. 2005 Emerging Markets Private Equity Association. "EMPEA Symposium: Investment Conditions Improving" Emerging Market Private Equity Association. June 2005 Emerging Markets Private Equity Association. "Institutional Investor Views on Emerging Markets Private Equity" Emerging Market Private Equity Association. May 2004 Emerging Markets Private Equity Association. "Survey of LP Interest in Emerging Markets Private Equity" Emerging Market Private Equity Association. April 2006 Emerging Markets Private Equity Association. Emerging Markets Fundraising Up Significantly for 2004 Emerging Market Private Equity Association. March 2005

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U.S. Institutional Investors Interest in Emerging Market Private Equity Emerging Markets Private Equity Association. Emerging Markets PE Returns Improving Emerging Market Private Equity Association. December 2005 Emerging Markets Private Equity Association. Emerging Markets Private Equity Grows, But Where are the Local Pensions Emerging Market Private Equity Association. December 2005 Emerging Markets Private Equity Association. EMPEA Advisor David Rubenstein Shares His Views on Emerging Markets Emerging Market Private Equity Association. December 2005 Emerging Markets Private Equity Association. EMPEA and Cambridge Associates to Collaborate on Performance Index Emerging Market Private Equity Association. March 2005 Emerging Markets Private Equity Association. Exits: $12bn Returned to Emerging Market PE Investors already in 2005 Emerging Market Private Equity Association. December 2005 Emerging Markets Private Equity Association. Fundraising for Emerging Markets More Than Double 04 Totals Emerging Market Private Equity Association Newsletter. Vol I, Issue 3 Q3 2005 Emerging Markets Private Equity Association. Fundraising More Than Double 2004 Emerging Market Private Equity Association. December 2005 Emerging Markets Private Equity Association. Improved Corporate Governance Driving Returns Emerging Market Private Equity Association. September 2005 Emerging Markets Private Equity Association. New Funds of Funds Increase Options for Emerging Markets Private Equity Investors Emerging Market Private Equity Association. March 2005 Emerging Markets Private Equity Association. US Industry Leaders Target Emerging Markets Emerging Market Private Equity Association. September 2005 Ernst & Young. Renewal and New Frontiers, Global Private Equity: Venture Capital Insights Report 2004-2005 Ernst & Young 2005 Ernst & Young. Transitions, Global Private Equity Insights Report 2006 Ernst & Young 2006 Froot, Kenneth A. and McBrady, Matthew. The 1994-95 Mexican Peso Crisis Harvard Business School. December 1999

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U.S. Institutional Investors Interest in Emerging Market Private Equity Hardymon, Felda and Leamon, Ann. Actis & CDC: A New Partnership Harvard Business School. April 2005 Hardymon, Felda and Leamon, Ann. Gobi Partners: October 2004 Harvard Business School. March 2005 Hardymon, Felda; Lerner, Josh and Leamon, Ann. Between a Rock and a Hard Place: Valuation and Distribution in Private Equity Harvard Business School. March 2005 Hardymon, Felda; Lerner, Josh and Leamon, Ann. CDC Capital Partners: December 2002 Harvard Business School. January 2004 Institute of International Finance, Inc. Capital Flows to Emerging Market Economies Institute of International Finance, Inc. 16 January 2003 Irwin, Brian P. Currency Crisis Harvard Business School. March 1999 Kennedy, Robert E. and Katherine Marquis. China: Facing the 21st Century Harvard Business School. January 2002 Khanna, Tarun and Palepu, Krishna. Emerging Giants: Building World Class Companies in Emerging Markets. Harvard Business School. September 2005 Khanna, Tarun and Palepu, Krishna. Spotting Institutional Voids in Emerging Markets. Harvard Business School. August 2005 Khanna, Tarun; Palepu, Krishna G. and Sinha, Jayant. Strategies That Fit Emerging Markets Harvard Business Review. June 2005 Kuan, Judy. Latin America Revisited Private Equity International. March 2006 Kuemmerle, Walter. Capital Alliance Private Equity: Creating a Private Equity Leader in Nigeria Harvard Business School. April 2004 Leeds, Roger and Sunderland, Julie. Private Equity Investing in Emerging Markets Journal of Applied Corporate Finance. Spring 2003 Leeds, Roger. Do Labels Matter Private Equity International. April 2006 Lerner, Josh. A Note on Private Equity in Emerging Markets Harvard Business School. November 2003 Lerner, Josh. A Note on Private Equity Partnership Agreements Harvard Business School. March 2001

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U.S. Institutional Investors Interest in Emerging Market Private Equity Lerner, Josh. A Note on the Private Equity Fundraising Process Harvard Business School. March 2001 Li, Shaomin. Why a Poor Governance Environment Does Not Deter Foreign Direct Investment: The Case of China and Its Implications for Investment Protection Kelley School of Business, Indiana University. 2005 McLelland, Albert and Zhang, Jiannan. Emerging From Turbulence Private Equity Annual Review 2005. 2005 Morse, Gardiner. Doing Business in a Dangerous World: Interview with Ambassador L. Paul Bremer Harvard Business Review. April 2002 Nualkhair, Chawadee and Kelleher, Brian. China Private Equity May Be a Minefield for Investors Reuters News. 15 December 2004 Palepu, Krishna G. The Right Way to Restructure Conglomerates in Emerging Markets Harvard Business Review. July 1999 Pill, Huw. Portfolio Capital Flows to Emerging Markets. Harvard Business School. February 2002 Pomerleano, Michael and Shaw, William. Corporate Restructuring: Lessons from Experience The World Bank. March 2005 Pozen, Robert C. Fixing the Pension Fund Mix Harvard Business Review. March 2004 Pozen, Robert C. Institutional Investors: The Reluctant Activists Harvard Business Review. January-February 1994 Rubenstein, David. "Have Emerging Markets Finally Left Behind Their Second Class Citizenship for Private Equity Investors?" The Carlyle Group. May 2006 Saigol, Lina and Smith, Peter. Trade Purchases are Back in Fashion Financial Times. 11 June 2005 Scheel, Barbara. ATP Private Equity Partners (B) Investment Strategy and Organization IMD International. September 2002 Snow, David. An Emerging Trend Private Equity Annual Review 2005. 2005 Snow, David. Diversify Your LPs Private Equity International. November 2005 Snow, David. Emerging Manager Mania Private Equity International. May 2004

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U.S. Institutional Investors Interest in Emerging Market Private Equity Wainwright, Fred and Colin Blaydon. Private Equity Finance Course Readings. Tuck School of Business at Dartmouths Centre for Private Equity. 2005 Websites VentureXpert by Thomson Financial (Online Limited Partner directory)

Conferences 2004 Annual Yale School of Management Private Equity Conference. 3 December 2004 2005 Asia Business Conference, Harvard Business School. 19 February 2005 2005 MIT Sloan Private Equity Symposium, MIT Sloan School of Management. 15 April 2005, 2006 Venture Capital and Private Equity Conference, Harvard Business School. 4 February 2006 Africa Business Conference 2005, Harvard Business School. 11-13 February 2005 The 2005 Emerging Markets Private Equity Forum, London, UK. Emerging Market Private Equity Association and Private Equity International. December 13-14 2005 Wharton Africa Business Forum 2005, The Wharton School. 19 November 2005 Wharton Private Equity Conference 2005, The Wharton School. 21 January 2005

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U.S. Institutional Investors Interest in Emerging Market Private Equity

Appendix 2. Questionnaire
Questions 1. What is your total capital under management? 2. What percentage of that is allocated to private equity? 3. Of the total allocated to private equity, what percentage of the private equity portfolio is currently invested in emerging markets private equity (EMPE)? Five years ago? What will it be in five years? 4. What is your strategy for EMPE? Global v/s regions v/s country funds, industries, early stage/buyout, funds of funds v/s direct investment funds, USheadquartered funds v/s funds based overseas, etc.? 5. What are the criteria that you use to evaluate GPs in EMPE? How do these differ from the criteria that you apply to GPs in non-emerging markets? 6. How important is the participation of a development finance institution DFI (e.g. IFC, EBRD, etc.) in a particular fund to your investment decision? How do you interpret this stamp of approval? 7. Are you more likely to invest in funds that already have capital committed by local sources? 8. Do you or will you invest in first time fund managers? If so, what are your criteria? 9. Do you have a dedicated staff to monitor EMPE investments? 10. What is the minimum return on any private equity fund that is acceptable to you? How does this threshold vary between developed markets private equity and emerging markets private equity? Do you expect higher returns for EMPE to compensate for political and currency risks? 11. Do you invest in public equities in emerging markets? If so, how do you compare those risks with the risks of EMPE? 12. Do you expect to increase your commitment to EMPE in the next five years? 13. What is your biggest constraint toward increasing your commitment to EMPE?

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Annex
About the Author
E. Brooke Whitaker is an MBA graduate from the Class of 2006 and was a research fellow at the Centre for Private Equity at the Tuck School of Business at Dartmouth. Prior to Tuck, Brooke spent 13 years living and working in Africa, the Middle East and Asia. He has led or has worked on over 80 sell-side transactions valued at over $3 billion across a broad spectrum of industries and sectors, has worked in almost 30 emerging market countries, and has resided for extended periods of time in Egypt, Thailand, South Africa, Kenya and Indonesia. Brooke worked for Andersen within its Global Corporate Finance/Emerging Markets practice from 1995 to 2002 and served on Andersens Emerging Markets Investment Committee, was a founding member of the Emerging Markets Core Team, was the regional manager for Africa, and was the key liaison to Andersen representative firms and numerous external professional advisory firms in the firm-wide provision of privatization and restructuring advisory services throughout Asia, the Middle East and Africa. Brooke is a published author of articles addressing African and Middle East international trade issues and can communicate in English, Arabic, French, Thai and Swahili. Email: e.brooke.whitaker@alum.dartmouth.org or ebwhitaker@btinternet.com Phone: +1-617-959-9196

Center for Private Equity at the Tuck School of Business at Dartmouth

The Tuck Center for Private Equity aims to advance the understanding of private equity investingthe engine behind the entrepreneurial activity that drives global innovation and productivity. The center focuses on macro and micro issues relating to private equity: capital markets, financing structures, governance and entrepreneurship. While an academic research center, the Tuck Center for Private Equity and Entrepreneurship is actively involved in the practitioning communities of private equity, both to gain information about current trends and challenges and to share insights and solutions. The center interacts with institutional investors, venture capitalists, buy-out investors, corporate venturers, angel investors, entrepreneurs, portfolio companies, industry lawyers and accountants, industry associations, and the media. Through these outreach efforts, the center also promotes networking that facilitates the pursuit of venture-backed activities.

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U.S. Institutional Investors Interest in Emerging Market Private Equity A thought leader in the field of private equity, the Tuck Center for Private Equity and Entrepreneurship's work is represented in prestigious publications and industry conferences. The center is a regular contributor to the Venture Capital Journal, the leading industry magazine, and its directors are often sought out as authorities by top business publications, such as The Wall Street Journal. The center seeks to educate Tuck students in entrepreneurship and private equity investing through such courses as Private Equity Finance, Advanced Entrepreneurship, Field Studies in Private Equity and through supporting internships, fellowships and independent studies. Center for Private Equity and Entrepreneurship Tuck School of Business at Dartmouth 100 Tuck Hall Hanover, NH 03755 Phone: +1-603-646-0522 Fax: +1-603-646-9084 Email: pecenter@tuck.dartmouth.edu Website: http://mba.tuck.dartmouth.edu/pecenter/

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