Drivers Unchanged

Vladimir Volkov

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Having spent almost a decade managing over $5 billion at Temasek Holdings and leading the Singaporean state-owned private equity giant’s investments in India, Africa and Russia, the founder and managing partner of Kedaara Capital, Manish Kejriwal, is now focused primarily on his homeland. Still, it doesn’t prevent him from spotting new investment opportunities in other BRICS countries, which he says are trying their best to improve their somewhat tarnished images as ‘investment destinations.’

Sovereign investment funds are a pretty new phenomenon, but are playing an increasingly important role in the global economic scene. Could you explain their purpose?

Broadly, there are two types of sovereign funds. First, funds which are essentially set up to maximize returns for their shareholders (which in most cases is the government) from their current budget surplus. A government contributes capital to sovereign funds in the years when there is a budget surplus and hopes that their managers can yield good returns in order to help future generations. These are more ‘passive’ in nature, with the primary aim to enhance investment returns. The goal for this type of fund is to minimize the volatility in a country’s economy and extend the benefit of its resources to future generations. Many of these countries are highly dependent on the extraction and export of natural resources like oil and minerals. Given that these countries have significant revenues in excess of their expenditures, a select number of these countries ‘save’ the excessive amount of revenue in any year to build up massive capital reserves, which are then deployed in a productive manner so as to benefit the country, especially in the years when the resources are no longer available or in short supply.

The second type of sovereign funds are more strategic in nature and essentially carry out a country’s or its leaders’ strategic objectives. These are funds which try to acquire controlling stakes in assets they consider ‘strategic,’ or would ‘simply like to own’ – for example buying into select European retail brand names, or niche investment banks. These are more ‘active’ in nature, and tend to exert direct control over their investments, unlike the passive investments mentioned above.

There are many examples. There are Norwegian and Chinese funds which are investing their capital surpluses to generate returns for their governments and people for the future, like the Chinese Investment Corporation (CIC). There are other funds within China which are specifically funded by the government to help Chinese companies acquire interests overseas (e.g. mineral assets in Africa, or stakes in foreign banks). They may not give returns to the shareholders in the near or immediate future, but they fulfill a strategic need for the longer term.

What type of sovereign fund is prevailing?

The majority of sovereign funds are more around the former type, where the funds want to maximize returns. In such cases, the first question which revolves around these fund managers is how they should do the asset allocation; in particular, how the capital should be allocated between debt and equity, and local and foreign assets. And if it is foreign, the question is whether they want a balanced portfolio, or only developed markets, or higher-growth emerging markets, and so on. All those sorts of questions need to be thought of by the CEOs and managers of the sovereign funds who are trying to maximize returns.

Do you believe such funds – of either type – can really work effectively, given that they are not wholly independent?

I do think that the effectiveness really varies by player. The most effective ones are those which have a firm mandate, and where the board has given a clear direction to the fund managers. It also helps if the fund managers are professional, and are incentivized to perform.

Most importantly, I believe the effectiveness truly depends on what sort of team the owners of the funds hire, and how their long-term incentives are structured. I have not done a study, but I would venture to say that the more professional and stronger the team is, and the more independent they are of their owner, the better they perform in terms of returns. Independent investment teams, which have a longer-term vision, provide a higher long-term return versus those which have to seek the approval of their shareholders for every investment decision they take. Look at the Canadian pension funds as an example. They have some of the most professional and best teams that you can find in the industry – and the incentives are in line with the best in class in the private sector.

So my overall point is that the performance of a sovereign fund is dependent on two things. One is the level of governance and the level of independence the team has from the fund’s shareholders. Another is the quality of the management team and their incentives – whether they are being paid at market rates so as to allow them to compete for talent with respect to the private sector. Generally speaking, the more the fund is run by the independent professional team, the more qualified the team is, the better will be the returns.

What essentially is the role of the owners or shareholders?

The role of the shareholders is to define the objectives and the mandate of the fund. They could potentially put some rules on the dos and don’ts for the team. But then they should – let me stress it again – leave the independent investment decisions to the management team. That is how you create the highest level of efficiency. It is inefficient when the team is actually made to go to the shareholders to get approval for each and every investment or hiring decision.

BRICS in Focus

It looks like investors are getting wary of the BRICS, both as a concept and as an investment destination. Why?

I do not think it is a long-term trend. BRICS economies and their respective markets are cyclical in nature, like those of the developed market economies. Investors have only seen one complete cycle (2003-2012) and many of them invested in the downturn and lost money. For example, of the total ~$70 billion invested by private equity funds in India in the 2000-2012 period, over 70% came in just three years (2006-2008), which were bad vintage years and gave poor returns. Investors faced a similar experience in other BRICS countries, like Russia and China, at the same time. All this has made them a little bit cautious about investing in BRICS.

BRICS economies and their respective markets are cyclical in nature, like those of the developed market economies. Investors have only seen one complete cycle (2003-2012) and many of them invested in the downturn and lost money. However, none of the fundamental drivers of the BRICS have changed. They remain large demand centers, and are high-growth economies. So I believe the foreign direct investment (FDI) flow in India – and in all BRICS economies – will definitely pick up in the next few years

However, none of the fundamental drivers of the BRICS have changed. They remain large demand centers, and are high-growth economies. So I believe the foreign direct investment (FDI) flow in India – and in all BRICS economies – will definitely pick up in the next few years.

Note that the BRICS governments are also introducing various reforms to increase the attractiveness of these countries as investment destinations. Take India as an example. In the last few months the cabinet has made efforts to bring the investors back. FDI caps in a lot of sectors of the Indian economy – including insurance, retail, and aviation – have been relaxed, and many regulatory policies have been streamlined.

Earlier this year you were quoted as saying that the world does not revolve around India. What did you mean?

That was partially said in jest. My point was that any country cannot take foreign investors for granted, and India is no exception.

International and global investors go where they believe they get the best risk-adjusted returns. So while they will go to growth markets, they will also penalize the country which has high levels of risk. In India, which is a very attractive and large growth market, the attractiveness is balanced by significant levels of risk in the regulatory area, and a mixed level of corporate governance. Hence, the government and the private sector should not take international investors for granted, and should strive to provide both regulatory clarity as well as good levels of corporate governance. This is a necessity if India is to attract the levels of foreign investment required to realize its full potential.

India’s regulators, policy-makers and private sector cannot remain silent on these challenges. This is exactly in line with your previous question. India consists of over a billion people but, in addition to a large and attractive market, the investment climate and regulatory consistency are equally important in attracting foreign capital to the country.

I continue to believe that India still remains a very, very attractive destination because the underlying growth is there, and there is a significant upside possible for investors who come here. However, India has to go a long way to minimize the risks, especially around the regulatory and infrastructure areas.

It looks like Russia is facing the same challenges. Based on your long experience as an investor in Russia, what is your evaluation of the country as an investment destination, and what would you advise the government to do to improve the climate?

Before I start you should promise me that whatever I say will not be used against me as grounds for denying me a Russian visa!

Please take it for granted.

Seriously speaking, in terms of the positives, I would like to mention the people who evaluated Russia as an investment destination in the middle of the last decade (around 2004-2006). They saw that the country was opening up for foreigners and that there was a significant investment coming in, especially in areas like banking, the financial sector, telecoms, retail, etc. Comparing the potential and the wealth in the country, they saw a huge opportunity in Russia, and wanted to introduce financial instruments and products to satisfy both corporate and retail clients. Many global investors were very excited by Russian investment opportunities.

What happened then? In what way has the attitude changed?

I see two big issues as an international investor evaluating Russia as an investment destination.

First are the underlying demographics of the Russian economy. When compared to markets like India or China, the demographics are working against the country. China and India are states with a substantially growing population. If you look at the population pyramid, the majority of the people in India are still below 30 years old. That has changed quite dramatically in Russia, where the average age in the population pyramid has moved to a much higher age group. In addition to that, the reality is that the Russian population is actually declining every year. This is very different from the growth in the other BRICS countries, which are benefiting from their ‘population dividend.’ In many of these states the large growth in population is driving the underlying growth in the GDP. Global investors are looking to see what level of GDP growth will be sustainable. An underlying worry is that if the population itself is falling in absolute numbers then, despite the increase in wealth, will the country eventually grow, or will you actually see demand destruction in the years ahead? In this sense Russia is not in a favorable situation compared with other BRICS countries.

Second, there is still a perception of the ‘invisible hand’ that influences decisions in Russia. This is especially the case with large multinationals whose investments in Russia have seen different challenges. There is a perception that certain large business houses have a significant advantage given their proximity to the state, and that their interests would always be protected, even if it is at the expense of the international investor. This may just be a perception, but in our world perception becomes reality, and the international investor tends to see that as an area of significant risk.

Beyond India

Is Kedaara Capital looking to invest in Russia or other BRICS countries beyond India?

Kedaara Capital was set up for a very specific purpose, which is to allow global investors to deploy capital and get an exposure to India in a number of very attractive, though specific, investment themes. That is why we do not invest beyond India, even though we consider it attractive to invest in other BRICS countries. The focus of this team will be very much restricted to India in order to maximize the risk-adjusted returns that our investors seek from this fund.

OK. But as a seasoned international investor, could you talk about which BRICS – and maybe not only BRICS – countries seem to be attractive destinations for a longer-term investment?

I think the BRICS countries will continue to be very attractive investment destinations for a wide variety of reasons.

Firstly, I believe their economies are still at the early stages of development, and there is still a significant need for capital for many sectors and industries to realize their full potential.

Secondly, countries like India and China are also seeing a dramatic increase in their population. Countries like Russia and Brazil are seeing not only significant discoveries in natural resources, but also huge growth in consumer demand in diverse industries, such as retail and financial services. Countries like South Africa will provide a great window to deploy capital in the rest of the continent and in some of the mining resources in the country itself.

So I do think, as an investor, I would put more money in emerging markets – especially in the BRICS. But there is also another country I like, which is Indonesia. Again it benefits from a large population, very good demographics, and lots of economic growth. I also used to like Turkey a lot, but it looks like the country has already got quite a lot of capital and is getting expensive.

Finally, I think another country that one cannot ignore is the United States. Historically the U.S. has always reinvented itself, attracted new talent, and done new things. What has made the story even more interesting today has been the dramatic increase in the country’s competitiveness, not least due to the shale-gas revolution. Thanks to the shale, the cost of energy in America has come down dramatically. This has not only helped lower the cost structure of various industries further downstream, such as petrochemicals, but has also made the U.S. economy a lot more competitive. It has also allowed the country to lower its dependence on foreign sources of energy. As a result of this, I actually see a lot of manufacturing going back to the United States.  


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