Private Sector Development and Finance

Future of Investment Funds Strategy

Investment funds operations are one of the crucial means for ADB to stimulate entrepreneurial finance and support sustainable economic growth. Investment Fund Operations deliver private equity to Developing Member Countries (DMCs), which simulates domestic market development and capacity-building and increases access to debt financing in its DMCs. Private equity is in high demand from ADB's DMCs, and is a standard modality for investment within ADB's peer institutions.

Strategic objectives for Investment Fund Operations include:

• to contribute in a significant way to the growth and sustainability of Asia's private equity industry
• to support institution-building and skills development
• to be an active investor, with an active approach to corporate governance and environmental standards
• to remain Asia's investor of choice for as long as ADB's support of the private equity industry is needed.

Investment Strategy

ADB invests in two kinds of private equity funds, which balances its goals of both financial and developmental returns:

• Economically focused funds: More mature funds guided by experienced, capable management teams investing in high-performing SMEs. Goals are to generate risk-adjusted returns, stimulate economic growth, and ensure continuity of capital flows, and



• Developmentally focused funds:Less mature funds with less experienced fund managers, often investing in more volatile markets or sectors, or utilizing new pilot investment models. Riskier investments that bring specific value-added to SMEs and financial sectors, including long-term / innovative financing, knowledge transfer, and capacity building. Actively develop DMCs' private equity markets.

ADB uses a portfolio approach to screen and evaluate transactions; structure and define its role in a given fund; and monitor and manage the risks associated with its overall investment funds portfolio. Funds are considered and rejected based on their "fit" within ADB's diversified target portfolio.

Developmental Effectiveness

ADB requires that its funds and their portfolio companies not only generate financial returns but also provide developmental inputs into the private sector. These include employment, infrastructure benefits, social and environmental benefits, good governance, and the creation of ancillary supporting businesses. PSOP has developed a database to dynamically collect and analyze information on its investments funds and the funds' portfolio companies, including financial performance, development outcome, and regulatory and legal barriers encountered.

In 2002, ADB's Operations Evaluations Department did an impact evaluation study of ADB's Investment Fund Operations. It concluded that Investment Fund Operations achieved "major development impacts" in five areas:

1. mobilizing significant financial resources for infrastructure development, direct investments in industrial enterprises, and portfolio investments
2. supporting SMEs and new entrepreneurs
3. supporting technology development
4. developing capital markets
5. generating employment.

ADB has a unique knowledge of and expertise in Asia's private equity markets and understands the risks in these difficult markets. ADB's presence in a fund provides comfort to private investors: they know that the legal structure of the fund will protect shareholders in the context of Asia's emerging economies, and that the fund has undergone thorough due diligence. ADB is particularly qualified to play a catalytic role because it combines three essential capabilities with respect to evolving Asia's private equity markets:

• financial resources that it can leverage against private investor funds
• credibility with governments that can be used to instigate much-needed policy and regulatory reform
• powerful influence with private investors that can be applied to encourage more active participation in private equity.

Public-Private Coordination and Synergies

For ADB to have a significant catalyzing and demonstrational role in developing Asia's private equity industry, its public and private sectors windows must work together closely. The public sector window needs to instigate reforms that will improve the environment for private equity, and link it with Investment Funds Operations. The level of collaboration between ADB's public and private sector operations is becoming increasingly important because private equity investors-ever more sensitive to location-specific problems-are beginning to assess countries based on criteria such as shareholders rights, tax treatment on capital gains, and securities market development.

In an effort to facilitate this kind of collaboration, ADB has developed a database to collect financial and non-financial information on its investments funds. Collected information includes the financial performance of the funds and portfolio companies, development outcomes, and regulatory and legal barriers that their portfolio companies encounter. The information collected will be reported on a regular basis to the regional departments to support the formulation of a conducive enabling environment for private sector development.