Considerations In Establishing Specific, Dedicated Allocations to Emerging Markets Infrastructure and Private Equity By Rich Nuzum, CFA Executive Director, Investments & Global Chief Investment Strategist, Mercer

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Some of the world’s largest, most sophisticated asset owners and fiduciaries (collectively “asset owners”) have established dedicated allocations to emerging markets infrastructure and/or private equity, as part of their strategic asset allocations or other means of deploying their risk budgets. This note is intended to help educate asset owners who have not yet established such allocations, regarding some of the common considerations that come into play as asset owners work through their deliberations on the pros and cons of establishing such allocations.

Some definitional issues

For purposes of this note, we define emerging markets infrastructure as one asset class, and emerging markets private equity, by which we mean venture capital and early stage growth private equity (as opposed to buyout), as a separate asset class. Further sub-divisions and other definitions are possible, but these are two “asset classes” we commonly see added for consideration, by asset owners that already invest in “infrastructure” and “private equity” in developed economies. In some cases, selective, opportunistic or more systematic investment is also deliberately made in some markets considered “frontier”. For simplicity, we explicitly consider emerging markets exposure only, while acknowledging implicitly that some institutional investors have gone beyond the emerging markets in an effort to potentially further enhance their expected returns and diversification.

We acknowledge that the distinction between “developed” and “emerging” is becoming less and less meaningful, and in any case was typically established for consideration of public market equity investments. For example, Taiwan has per capita GDP of US$32k per annum as of 2022 (non-purchasing power parity adjusted), and South Korea $33k per annum, just below Japan’s per capital GDP of $34k.3 Taiwan’s corruption perceptions index score is 68, just one point below the United States score of 69 on a 100 point scale. (Japan has a score of 73 and South Korea a score of 63.)4 To be provocative, if we took the facts, data and experience of policymaking and government/regulatory stability in the US and UK since 2016 – a period which has seen populist political outcomes in both countries, a government bonds crisis in the UK that forced a government out of power, repeated threats to shut down the US government, a physical invasion of the US capital building, etc. — and documented these facts while leaving out the names of the countries, would an impartial observer perceive these countries as “stable”?

Nonetheless, we observe that most asset owners, other than those that are actually domiciled in an emerging/frontier economy as their home market, typically begin their infrastructure and private equity investment programs by investing in “developed” economies, where regulation, available court precedents, and the perceived “rule of law” tend to be stronger. As these developed market-focused programs are deployed and gain critical mass, adding dedicated strategic exposure to the rest of the world (i.e. to the emerging markets) is typically taken up as a separate and distinct issue. In this context, this note is likely most relevant for asset owners that already allocate to infrastructure and private equity, with a focus on developed markets.

One common driver for emerging market allocations to be given explicit consideration is the recognition that most of the world’s economic growth is being delivered by the emerging markets, and that this is projected to remain the case for the foreseeable future given demographic trends and the opportunity for emerging economies to leapfrog technologies and move up the per capita GDP curve relatively quickly. Another common driver is recognition that commercial general partners and in-house investment staff, unless they are given specific direction to undertake due diligence efforts focused on emerging markets, will tend to only make such investments opportunistically, tactically and at the margin as part of “global” mandate. As such, an asset owner may observe that its infrastructure and private equity programs, which were intended in part to provide diversification, are actually exposed mainly to the same local economic drivers as its public markets equity and fixed income programs.