Emerging Middle Markets: Closing the Gap Between LP Ticket Sizes and Mid- Market GPs

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Over the last few years, we have seen a significant drop in private equity capital flowing into emerging markets, with a greater percentage of this funding concentrating on a fewer number of larger funds active in a handful of core markets. Average fund sizes have more than doubled in the last three years, while the total number of funds holding closes has declined – 96 emerging market funds held final closes on an average fund size of US$192 million in 2009 versus 84 funds closing on an average final fund of US$419 million in 2011. In fact, through the first three quarters of this year, the 10 largest funds raised accounted for over half of all capital going to the asset class.

As we near the end of 2012, fundraising continues to be a serious challenge for the emerging markets private equity industry, and for mid-market fund managers in particular. As institutional investors look to increase their allocations to our asset class, while at the same time reducing overall costs, many are choosing to focus on a small universe of fund managers, thus facilitating the conditions for ballooning fund sizes and effectively creating a financing gap for mid-size funds trying to raise capital. A cycle has come into play of larger LP commitments fueling larger funds, and larger funds necessitating larger checks.

A flight to perceived quality is a natural reaction for investors; however, the concentration of capital going to a handful of emerging market funds is also exacerbating the problem. If this trend continues, several key challenges for the asset class will arise – too much capital chasing a limited number of large deals will inevitably pressure valuations and drag down returns. But perhaps more importantly, LPs are not accessing mid-market growth opportunities, and viable emerging market-based businesses operating in the middle market segment and below will find themselves starved of crucial capital. This article takes a closer look at some of the market dynamics at play, with a focus on how LP commitments are driving increasing fund sizes in emerging markets, in hopes of setting the stage for greater industry dialogue on how to bridge the growing gap between LP ticket sizes and mid-market GPs.