# **1 Introduction**

This paper provides the first evidence on returns to private equity investment in emerging markets using consistent data for a long period of time. Specifically, we analyze the cash flows associated with every equity investment made by the International Finance Corporation (IFC), a member of the World Bank Group, which invests across 130 emerging markets including the poorest and most neglected by private investors. Founded in 1956 with a mandate to “further economic development by encouraging the growth of productive private enterprise in member countries, _particularly in less developed areas_ ,” the IFC’s charter includes the goal of achieving market rate returns in markets “where sufficient private capital is not available on reasonable terms.” The portfolio is free of sampling problems, such as survivorship bias, and is much more diversified across countries than either foreign direct investment (FDI) inflows or the MSCI Emerging Market (MSCI EM) index of publicly-listed equities, both of which are highly concentrated on larger emerging market economies like China and Brazil. This unique dataset enables us to address long-standing questions relevant to international finance and development economics.

First, what is the performance of a diversified investment strategy focused on emerging markets? There is broad divergence in priors over whether this strategy can achieve returns comparable to those in advanced economies. Because we observe the timing of cash flows, we are able to measure returns in terms of a public market equivalent (PME) that accounts for both the absolute level of return and correlation of return with a global risk factor, as in the capital asset pricing model (Kaplan and Schoar 2005, Sorensen and Jagannathan 2015, Korteweg and Nagel 2016). Benchmarking the IFC’s complete equity investment portfolio to the S&P 500 index (available for our entire sample period of six decades), we calculate that the complete portfolio has obtained a PME of 1.15, indicating that it has returned 15 percent more over its life than an equivalently timed investment in the public index.

Given that these data represent the portfolio of a single investor, we do not claim the reported performance to be representative of the universe of emerging market private equity investments. Nor is it clear that any other asset owner could replicate the IFC’s strategy and returns. Nonetheless, our results may offer an upper bound estimate for what diversified investors can achieve in emerging markets.

The IFC makes equity investments primarily through the direct purchase of a minority stake in a company, but also through participation as a limited partner in a fund. Direct investments (2,029 of 2,509) predominate in the sample. The academic literature on private equity almost exclusively focuses on returns to limited partners (LPs) after general partners (GPs) charge management fees— typically 1-2% of assets per year, and 20% of profit known as “carry.”<sup>2</sup> Our finding of a PME of

> 2For a survey of the U.S. literature on LP performance see Kaplan and Sensoy (2015). We venture the focus on LP performance is for three reasons: (i) these are the only data academics have been able to obtain, (ii) a lot more money in the world can be used as LP money than GP money, and (iii) the GP is a very specific skill set.

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