It seems the term ?political risk? is regarded as fighting words these days by the small but dedicated group of general partners who are active across emerging markets. At the 2005 Emerging Markets Private Equity Forum, held in December in London, GPs bristled at the notion that political risk is something LPs should spend much time worrying about, given the array of other more important and controllable risk factors.
Political risk, they explained, is a rather fuzzy term that includes, as a worst case scenario, the loss of investment due to the collapse of a government, or perhaps the seizure or destruction of a business due to political unrest or radical policy change. But the term has also been applied to include everything from corruption to regulatory change. These risks can be carefully measured and factored into an investment decision like any other factor, the GPs argued. In other words, entire countries should not be avoided based on an ill-defined perception of political risk.
At a roundtable discussion that was part of the forum's agenda, Ettore Biagioni, managing partner at New York-based, Latin Americafocused buyout fund Alothon Group, said it was important to find companies that will do well in a variety of economic and political environments. That said, Biagioni noted he avoided industry sectors that are ?politically charged? and therefore subject to greater government involvement. He said the problem of corrupt government officials is a matter that can be uncovered and analyzed in quality due diligence, an expense that GPs ?can't skimp on.?
Speaking in a keynote address, Paul Fletcher, the senior managing partner of London-based global private equity firm Actis, noted that Western limited partners in particular worried about political risk in emerging economies because ?the further away from a market, the greater the perceived risk.?
In reality, Fletcher argued, political issues rarely erode the value of portfolio companies. No, investment failure in emerging markets much more often comes from plain vanilla governance and management problems.
By contrast, argued Fletcher, the perception of political risk can more often create opportunities for private equity investors targeting the region in question.
Fletcher noted a recent exit enjoyed by his firm that returned 2.6 times Actis' capital and produced a 36 percent IRR. The portfolio company is located in Zimbabwe, better known as a site of political repression. However, according to Fletcher, in Zimbabwe ?MBOs are king.?
A lighter moment came in an exchange overheard between a forum delegate and the manager of a Russia-focused private equity firm. The delegate asked a question about political risk in Russia, to which the GP replied: ?What do you mean by political risk? Do you mean Stalin coming back from the grave and killing all the fund managers??
It would be difficult indeed to know who to call to control for this specific contingency. Ghostbusters?