Learning Curves

OED
July 2008

PrivateEquityFundOperations

Privateequityfundsgivesmallandmediumenterprisesaccesstotechnologyandequity capital.Asiaisthedominantdestinationforprivateequityinemergingeconomiesannual fundraisingrosefrom$2.2billionin2003to$23.1billionin2007,concentratinginIndiaand thePeoplesRepublicofChina. HalfofADBsoutstandingcapitalcommitmentstoprivateequityfundswereapprovedfrom 2003.Theportfolioisconcentrated,withtwocountriesmakinguphalfofinvestment(and fourcountriesaccountingforthreequarters.)Regional,nonsectorspecificfundsdominate, forminghalfofinvestments.Telecommunications,transport,andutilitiesexplainhalfof investments.Arecentevaluationstudyratedoperationspartlysuccessful.

mobilization,andevidenceofpositivedirectcompany outcomes.Butbusinesssuccesswaslessevidentand Almostallmultilateraldevelopmentbanksand assignedaratingofpartlysatisfactory.Issuesof bilateraldevelopmentfinanceinstitutionsinvestin environment,social,health,andsafetyappearedto privateequityfundstopromotesmallandmedium havebeenaddressedeffectivelyandwerejudged enterprisesindevelopingcountries.TheAsian satisfactory.Asdevelopmentimpactsinthepast DevelopmentBank(ADB)madeitsfirstinvestmentin appeartohavebeenpositive,privateequityfundsare 1983.Betweenthenand31December2007,investments profitable(eveniffinancialinternalratesofreturns in75privateequityfundswereapprovedfora havenotexceededtheircostofcapital),and combinedvalueof$900million.Suchinvestmentsare environmentandsocialperformancemetexpectations, nowacoreactivityofthePrivateSectorOperations anoverallratingofsatisfactorywasgiventothe DepartmentinADB:at31December2007,ithad40 developmentoutcomesandimpactscriterion. activefundswithatotalapprovedvalueof$676.4 ADBinvestmentprofitabilityhasbeenimprovingbut million. overallperformancehasbeenpoor.Thenominal In2007,buildingonworkperformedin2002,the financialinternalrateofreturnfortheportfoliowas OperationsEvaluationDepartmentinADBconducteda 7.5%,slightlymorethan50%ofADBsaveragerequired SpecialEvaluationStudyonPrivateEquityFund rateofreturnforprivateequityfundsof14.3%.ADB Operations 1 toidentifyhowtheircontributionto investmentprofitabilitywasratedunsatisfactory. privatesectordevelopmentmightbeenhanced.The ADBworkqualitywasevaluatedinconsiderationof portfoliowasexaminedintermsof:(i)development (i)screening,appraisal,andstructuring;(ii)monitoring outcomesandimpacts,(ii)ADBinvestmentprofitability, andsupervision;and(iii)ADBsroleandcontribution (iii)ADBworkquality,and(iv)ADBadditionality. totheprojects.Thestudynotedthatthescreening SummaryofFindings processhaddemonstratedalackofstrategicfocus,and theidentificationofinvestmentshasbeenprimarily ThedevelopmentoutcomesandimpactsofADBs privateequityfundoperationswereevaluatedfromthe reactiveinresponsetosponsorsapproachingADB. Appraisalandstructuringhadbeensatisfactory. standpointsof(i)privatesectordevelopment;(ii) However,postinvestmentapproval,fundshadoften businesssuccess;and(iii)environment,social,health, departedsignificantlyfromapprovedinvestment andsafetyperformance.Theprivatesector conceptsandfewmechanismswereavailabletothe developmentcriterionwasassignedaratingof PrivateSectorOperationsDepartmenttomitigatethis satisfactoryduetogenerallypositivebeyond risk.Monitoringandsupervisionhadbeenweak, companyimpacts,especiallywithregardtoresource
Operations Evaluation Department Asian Development Bank 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 632 4444; Fax +63 2 636 2444; evaluation@adb.org; www.adb.org/evaluation/

Background

primarilyduetodisparityinthequalityofreporting andweakinformationmanagementsystems.Once fundingiscommitted,thedepartmentislargely dependentuponfundmanagerstoachievepositive developmentandfinancialresultsbyrelyingupona combinationofcommercialincentivesandasetofhigh levelinvestmentrestrictionsthathavelittlerelationship withdevelopmentobjectives.Asaresult,theoverall ratingforADBsworkqualitywaspartlysatisfactory. ADBadditionalitywasexaminedbasedonwhether ADBfinancehadbeenanecessaryconditionforthe timelyrealizationofinvestments,andADBs contributionandfunctionhadimproveddevelopment impact.ThestudyindicatedthatinthepastADBs participationhadprovidedadditionalitybycatalyzing privateinvestmentinprivateequityfunds.However, thisimpacthadbeendecliningovertimeduetothe continuedfocusonIndiaandthePeoplesRepublicof China,whereADBsdemonstrationandriskmitigation impactsforprivateequityfundshavebeendecliningin recentyears,asdemonstratedbytherapidgrowthin privateequityinthesemarkets.Duetoresource constraints,thePrivateSectorOperationsDepartment hadhadlimitedabilitytodirectlyaddvaluetoprivate equityfundoperationsandstrengthentheir developmentimpacts.TheratingforADBadditionality wasjudgedpartlysatisfactory. AssessmentofADBsPrivateEquityFundOperations
Criterion DevelopmentOutcomes&Impacts PrivateSectorDevelopment BusinessSuccess Environment,Social,Health& SafetyPerformance ADBInvestmentProfitability ADBWorkQuality ADBAdditionality U X PS X X X S X X X E

and(vii)theadequacyofresourcesformanagingthe privateequityfundportfolio. Recommendations ADBsManagementwasinvitedtoconsider: Strengtheningcountryprogrammingarrangements sothereisbettercoordinationwithinADBatthe countryandsectorlevelwhenseekingtodevelop thenonbankfinancialsectorforprivatesector development. Preparinganoperationalstrategyforprivateequity fundsthatwouldsetoutprinciplesformanagingthe overallportfolio,andidentifytargetedcountriesand subnationalregions,sectors,stagesoffirm development,stylesandsizesoffunds,anddesired developmentimpacts,forcirculationtoallregional departments. Upgradingportfolioplanningandmanagementand reportingsystemsforprivateequityfundsto facilitatemanagementasastandaloneportfolioand reinforcedevelopmentimpactmonitoring. Strengtheningtheriskmanagementsystemsfor privateequityfundsbyputtinginplacecapacityto independentlymonitorprojectspostapprovalfrom afinancial,social,andenvironmentalperspective. Clarifyingorganizationalrolesandresponsibilities, withparticularregardtomakinggreateruseof residentmissionsforoperationsinprivateequity funds,andtheneedtocomplementregional departmentoperations. Allocatingsufficientresourcesintheareasof budgetingandstafftoefficientlyandeffectively manageoperationsinprivateequityfunds. Feedback AtthetimeofpreparationoftheseLearningCurves, ADBManagementsResponseandtheChairs SummaryoftheDevelopmentEffectiveness CommitteeDiscussionswerenotyetavailablefor disclosuretothepublic.Thestudywascompletedin July2008. 1 ADB.2008.SpecialEvaluationStudyonPrivateEquity FundOperations.Manila.Available: http://adbweb/Documents/SES/REG/SSTREG2008 17/SSTREG200817.pdf

Legend:E=excellent,PS=partlysatisfactory,S= satisfactory,U=unsatisfactory. TheoverallassessmentofADBsprivateequityfund operations,asjustifiedbytheunderlyingratingsfor developmentoutcomesandimpacts,ADBinvestment profitability,ADBworkquality,andADBadditionality waspartlysuccessful. Thestudydiscernedissuestouching:(i)the developmentjustificationoffunds,(ii)thebalancein ADBsportfoliobetweenprivateequityfundsand directequityinvestments,(iii)lackofstrategicfocusof fundoperations,(iv)styledrift,(v)weaknessesin managementreporting,(vi)theorganizational frameworkforprivateequityfundoperationsinADB,
Learning Curves available @ www.adb.org/evaluation/

Team Leader: Bob Finlayson; Tel +63 2 632 4107; bfinlayson@adb.org