Since January 2014, exchange rate movements have subtracted value from realized private equity investments in emerging markets of nearly 60% of respondents of the latest EMPEA survey, with several respondents estimating losses of $500m.

EMPEA’s Currency Risk Management Survey, released in partnership with AMEXCAP, is the first examination of the impact of currency volatility on the emerging markets private equity (EM PE) industry.
The survey analyzes the views of 146 practitioners, representing both fund managers/general partners (GPs) and limited partners (LPs).

According to EMPEA data, nearly 25% of the capital invested in EM PE deals between 2013 and 2015 has been deployed into countries that have experienced a depreciation of 30% or more in their currencies against the US dollar.

While almost 75% of global investors surveyed for this study agree that currency risk is an important or very important factor for their firm, there is a lack of agreement on how to measure and mitigate this risk.
According to the findings, a majority of respondents—63% of LPs and 57% of GPs—do not construct their portfolios with currency risk as an explicit objective.

Meanwhile, among the 68 respondent firms that have implemented FX hedges, less than one-third report that they have paid off, while 38% report that it is too soon to say.

If the diversity of opinions and strategies that this inaugural survey revealed could be summarized into one conclusion, it may be that while LPs must acknowledge the currency risk associated with EM PE investments and view it as diversification within their portfolios, GPs should give due consideration to managing their portfolios to perform in the functional currency, sourcing deals with natural hedges or pricing power when appropriate, and consider selectively employing hedges (when reasonably priced) on entry and exit.

Michael Casey, Senior Director, Consulting Services at EMPEA and lead researcher on the report, said: “Over the long term, the gradual opening up of local institutional capital across the emerging markets is one of the most promising developments for the mitigation of currency risk and the growth of EM PE as an asset class.”

“Matching a fund’s functional currency with its investment destination can enhance alignment of GP and LP interests, allowing GPs to concentrate on generating alpha, and enabling LPs to harvest the outsized returns that PE can bring when done well,” he said.

From a GP’s perspective, Tom Speechley, Partner and Head of Global Markets at The Abraaj Group, added that investing in global growth markets has many challenges when it comes to managing currency risk.

“GPs who take a holistic approach that differentiates company-specific currency risks from those that are related to macroeconomic factors, who are aware of the limitations of financial market products, who have strong systems and processes in place to understand and price the risk, and who have a flexible investment mandate are the ones who will be turning the higher risks they are taking into higher returns,” he said.