The Stern Opportunity

Issue date: 3/9/10 Section: News

On one of the snowiest days of 2010, twenty students from the Emerging Market Association arrived at the office of Zephyr Management to discuss one of the hottest themes in investing. The group sat around the well-known Zephyr board table to listen to Tom Barry, CEO of Zephyr, and Stephen Canter, COO, speak about their strategy for investing in emerging markets and some of the challenges they face. Mr. Barry began his post-MBA career at T. Rowe Price Associates, where he ran a large mutual fund of small capitalization companies. He became President and CEO of Rockefeller & Co., the investment arm of the Rockefeller family, before founding Zephyr in 1994. Since then, he has led Zephyr in investing about $1.5 billion in emerging market private equity and marketable securities. Mr. Canter kicked off the presentation by discussing the approach to investing in marketable securities. He explained how the two funds, one a global emerging market fund, the other a pure Latin American fund, employ global teams with geographically specific expertise, performing fundamental Graham-Dodd security analyses to pick undervalued stocks that fit the firm's current macro themes. Interestingly, Zephyr is benchmark blind, and instead focuses its performance on a net annual return of 15%, a target rate that they have exceeded since inception, even following the events of 2008. And they have achieved this without employing leverage, as dictated by Zephyr's overall investment philosophy. Mr. Barry, dressed in a suit and his trademark striped bow tie, explained that the overall philosophy at Zephyr is to identify a country or region where they believe there is a compelling story and then think about the best way to invest there. In regions such as Latin America, where the stock market is relatively advanced and Zephyr has an expert research team, they may choose to invest in marketable securities. However, in regions of Africa, where they believe the stock markets do not provide adequate liquidity and corporate governance is not yet strong enough to protect shareholders, they invest directly in regional, multi-country companies. As Mr. Barry explained about the employment opportunities their development capital brings, they "are doing good by creating sustainable jobs that carry on, even if and when Zephyr leaves" by helping Zephyr's portfolio companies scale up. In the case of India, Zephyr knew it wanted to be involved in that growth story for many years, but it took until 2006 to devise a strategy that went beyond merely copying the hundreds of other funds investing there. They decided to focus on sectors in India well positioned to benefit from the growing middle class and increasing domestic demand, and identified the specific niches of Infrastructure Related Services, Education and Training Services, High-Value-Add Manufactur-ing and Financial Services. It became apparent that the best way to access companies in these niches and earn attractive returns was through private equity, which led to raising the Zephyr Peacock India Fund. Mr. Barry's enthusiasm for doing business in emerging markets and his energetic description of Zephyr's consistent, highly rational investment approach were inspirational, and the fifteen minutes left for questions were decidedly too short. During the questions, Mr. Barry discussed some of the relative benefits of equity investing and how Zephyr manages the risk of each asset by focusing on the entrepreneur and providing management support. A key part of Zephyr's competitive advantage is in the rigorous pre-investment diligence process. This is all the more important for Zephyr, as they will only ever take a minority position and therefore must rely on the entrepreneur's vision and management skills. Mr. Barry emphasized the human aspect of each deal, as Zephyr's position as a minority shareholder relies on the entrepreneur being receptive to constructive criticism. Judging from the consistent success that Zephyr has had across all geographies in private equity, it seems that this tried-and-tested approach is effective at creating significant value for investors, building great companies and contributing to the growth of these emerging market economies.

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