Rupee fall may play spoilsport for private equity firms
Dollar realizations have declined for private equity investors due to a weaker rupee, experts say
Mumbai: Private equity investors could see their returns come under pressure as their US dollar realizations have plummeted due to a weaker rupee, said experts. “The rupee depreciation definitely impacts returns on exits for private equity firms negatively,” said Rishi Kohli, chief investment officer and managing director at ProAlpha Systematic Capital, a subsidiary of US-based investment advisor, Monsoon Capital.
Explaining the impact of the fall in the rupee, Kohli said: “Suppose an exit that was expected to happen in December 2017, has got postponed and is happening now. As rupee has depreciated more than 10% in this interim period, what it means is that the returns on this exit for the private equity firm in dollar terms are reduced by that 10%. Now, if the IRRs (internal rate of return) on this investment have been say 15% and it has been 5 years, it means the IRRs will become 13% now, so definitely, it becomes meaningful.”
IRR is a concept used in measuring performance in private equity funds.
Between the June quarter and now, the exchange rate has weakened almost 13% to 72.71, from 64.47. On paper, investments made, for example, in 4Q2017 and 1Q2018 have to demonstrate gains of more than 13% in less than a year just to overcome the currency volatility, the experts said.
“The 2018 rupee slide has brought India-related macro concerns to the fore again. Since 2013, the rupee had been fairly stable as a result of which macro-related risk premium on India had reduced,” said Gopal Jain of Gaja Capital, a private equity firm with close to $500 million in assets under management.
Jain said the “depreciation has once again focused investor attention on India’s twin deficits.” “Risk premiums therefore will increase and will affect investments more than exits. But as every exit requires a buyer of some kind on the other side, exits too will be affected,” he said.
The pain is felt across the board with other private equity fund managers also seeking public market investing strategies.
“We raised our fund two years back when the rupee was at 63-64 against the dollar and now its at 72.5 against the dollar, it just means that no matter how well you do, you have already lost more than 15% to the currency,” said S. Harikrishnan, managing partner at Blue Lotus Capital Advisors, which manages a PIPE (private investment in public equity) fund of about ₹250 crores.
“Currency volatility is proving to be a big concern. As a ten-year fund, we factor in fall of 1% to 2% annually of currency risks, but such a dramatic fall in rupee creates havoc and directly impacts the NAVs of our funds,” adds Harikrishnan.
Currency volatility is also a concern for fund managers on the fund-raising front too, especially when it becomes a choice between India and other fund managers in the emerging markets bucket.
“The Indian currency, over the last 8-9 years, has depreciated on an average 4-5% every year. On the other hand Yuan, except for the last 18 months, has appreciated by 2% per annum. So if you made a IRR of 20% in rupee, with depreciation your dollar returns eventually comes down, while for Chinese funds the dollar returns go up,” said a manager of a large domestic private equity fund.
However, as more than 80% of the private equity monies are raised from foreign limited partners (LP) who set a dollar return hurdle rate, such trends highlight the pressing need of developing a local capital base of investors in private equity funds.
“This episode highlights the need to develop a robust domestic LP ecosystem. IVCA is playing a pivotal role here but we need greater support from policy makers. Currently the scale of rupee LP capital available is limited and is not sufficient to support the scale the industry has reached. We should encourage the development of domestic funds of private equity funds,” said Jain.
Some funds have dual component structure (offshore and onshore)—with some portion of capital being domestic so that it provides a natural hedge against such external factors. “This definitely becomes a good thing for the GP as some of the carry is linked to INR returns and some to USD returns and even if INR depreciates, the carry due to USD returns goes down as USD returns get impacted but the carry on the INR returns of domestic investors does not get affected. So this becomes a hedging strategy for GPs,” said Kohli at ProAlpha Systematic Capital.
Hedging becomes difficult for private equity funds where exit events cannot be planned. “There is no certainty on exact timing of exits and hence it is difficult to hedge the risk. Under such circumstances, hedging would be tantamount to speculation,” said Padmanabh Sinha, managing partner at Tata Opportunities Fund.
Plus it comes at a cost. “Currency hedging has its own issues with average costs over the past 10 years having been 5.5-6% which makes private equity firms reluctant to assume this high impact upfront,” said Kohli.
“Growth is the best hedge against rupee depreciation. The traditional approach of hedging against rupee depreciation by investing in export oriented businesses is viable but not scalable,” said Jain at Gaja Capital.
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