Clemens Feil: Weaker Emerging Market Returns, Impact Investing Paradox & Growth Equity Fundamentals (Active vs. Passive) - E240

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“Investing in emerging markets should be an impact investment if it’s done the right way. They also don’t lead to lower returns. Impact investment is defined by three things: additionality, which means contributing capital and tying the outcome you want to your investment; measurability, which means measuring the social outcomes you have; and intentionality, which is declaring where you want your impacts to be.” - Clemens Feil

Clemens Feil is a growth equity investor at the International Finance Corporation, where he leads investments in Asian emerging markets for companies in services industries to scale beyond the venture phase. He aims to create a sustainable investment ecosystem in emerging markets with measurable impact and strong returns. He has over a decade of experience in private equity investing and has led investments across various industries and countries. He holds a BSc from the London School of Economics (LSE), an MA from Columbia University, and an MBA from Harvard Business School.

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Jeremy Au: (00:50)
Hey, Clemens, really excited to have you on the show, obviously there are a lot of questions in the world about impact investing and growth equity, what happened to the stock market and technology and what happened to emerging markets/Southeast Asia. And I think you are the perfect person to shine the big spotlight that talks about the facts and about what's actually going on, so please could you share a little bit about yourself?
 
Clemens Feil: (01:20)
Absolutely. First of all, thank you, Jeremy. Thanks for having me on. It's really a pleasure to be here. Thanks for having me on this podcast. So I'm a growth and equity investor at IFC, the International Finance Corporation, which is part of the World Bank. And the World Bank's mandate is the reduction of poverty in developing countries or emerging markets, as some people call them. The World Bank is engaged in a lot of activities. As you can probably imagine, it's a big organization. There is the traditional World Bank site, which works with governments so with the public sector, and then there's the IFC where I work which invests in the private sector. And the IFC is engaged in a lot of activities too. There is a large part that invests in infrastructure and in energy projects. A lot of investments are debt, there is a venture team, there is a fund investing team. And I personally work in a growth equity team, which means I focus on transactions, on companies that have grown and matured out of the venture phase but are still not large enough to attract large debt financings.
 
Jeremy Au: (02:05)
Amazing, so, how did you get into investing? I mean, you studied at London School of Economics, in Columbia University. And then later on, you're going to Harvard Business School for your MBA but how did you get investing because a lot of folks are like I want to join a company or folks that like I want to build something and then some people are like I want to invest, which is very different from I want to be a banker. So tell me more about how private equity investing came about.
 
Clemens Feil: (03:33)
It's a great question. And it actually just happened, frankly, because I grew up in Austria. I'm actually Austrian. I grew up in Vienna, and my father's a doctor. So growing up, I didn't really know anything about finance or private equity or investment banking for that matter. In fact, when I started in London, my first internship at Goldman Sachs was an investment banking. I didn't really know what investment banking was. And I learned what a merger was. And people ask questions about EBIDA and I didn't know if that's something to eat, or whatever it is. So I happen to slide into that. But my first internship was really exciting. And I realized that a lot of aspects of the job there really enjoyed. There's a lot of working with companies, it's not just sitting behind the computer screen. It's exchanging ideas, it’s learning something new every day, and I really enjoyed that aspect of it. And in my second year, I had a summer internship that I shared between private equity and investment banking or traditional M&A. And I really enjoyed the investing side. What I really enjoyed more about it was, it's very goal-oriented, you don't really work for a client, you work for whatever you think are interesting things that you want to learn about and know about this company. And you focus on the things that are essential or important and have to discern those. And that's actually part of the work that I really enjoyed.
 
So when I graduated from school, my first job was in private equity at Neuberger Berman in the New York office, where I spent four years. And then I spent two years at SCDNR Clayton Dubilier and rice also in New York, where I worked in large-cap transactions. And then I went to business school where we met for the first time and then joined Bain Capital and then when I think back on what led me to this path to IFC and investing with impact. It's actually pretty interesting because my first job at Neuberger Berman, I spent mostly investing in the Americas, so a large aspect was investing in more mature companies in North America. But it also helped build a Latin America strategy, which invested in more emerging and growth equity, earliest stage companies in Latin America and I found that aspect of investing really exciting and after two years SCDNR were worked on large-cap LBOs before going to business school, business school forces upon you this consideration of what do you want to do in life? What do you want to do with your one wild and precious life and almost forced this quarter-life crisis upon you on what is your goal in life and your motivation?

And I tried to be really introspective because until then, I hadn't really thought about it. I slid into my initial investment, banking and then investing. And I never really looked left and right and thought about what am I passionate about, what I wanted to do. And then I thought back on the time that I invested in Latin America and the fund that we raised and built, had purely financial goals, it was not an Impact Fund, back then they weren't really talking about impact investing. It was purely driven by us trying to find the best returns for our investors. But now looking back, every investment that we did was an impact investment. We helped build schools and hospitals and logistics in Brazil, and Colombia, and in Peru, and I found that investing extremely rewarding. Because when you go there, and you see a school and suddenly there are children studying in a school that you built, and their teachers hired with the money that you provided, and your nurse is being hired in hospital. And at the same time, you're actually achieving returns for your investors. To me, how can it be any better than that? So that's what when I went really introspective, that's what I've chosen wanted to do with my life coming out of business school. And so after business school, I joined Bain Capital, with the intention of raising a billion-dollar emerging markets growth equity fund. And we had a great team. And we invested globally, very opportunistically.
 
We invested in India and Vietnam and Pakistan and South Africa. Eventually, it was decided strategically not to pursue that fundraise anymore. So we invested just with partner capital, which then led me to move out of Bain Capital. And I would say, looking back a difficult decision for me to make, which is, should I stay at Bain Capital, I had the opportunity to move to other parts of Bain? Should I just go back to North American large-cap private equity? Or should I follow my heart and my passion and be stubborn about what I want to do, which is emerging markets growth, equity, investing with a positive development impact on local communities, and I stuck with that, I stuck with the latter. So I moved to IFC, or now oversee growth equity investments across Southeast Asia, focused on emerging markets countries.
 
Jeremy Au: (9:45)
So, you say something about how it feels amazing to be helping build schools and obviously generating returns that feels contrarian. Is it investing bad? Is it capital bad? I think that's a very strong view, I think this financial system is broken and that generates bad outcomes. So how is it that like you said growth equity plays a role in society and the things that we see today.
 
Clemens Feil: (10:14)
I think that's a great question. And a lot of people have been asking that. And I'm not sure there is a very clear answer. But I think what we can first of all do is we can separate developed markets, from emerging markets. In developed markets, you generally have an abundance of capital, of course, there's a location issue where exactly geographically within the United States does the money go, and then which communities and which groups and, male founders, female founders, I understand all of that is complicated. But generally, there is enough capital available. In emerging markets, you don't have that, you generally don't have enough capital available. So when you look at smaller companies that are growing fast, hospitals, or schools that are expanding rapidly, for the most part, they don't have the growth capital to expand, they're too small for bank financing. But there is not enough equity to go around to help them expand. So there's this fundamental difference. And in that sense, when I think back on the investments that we did in Latin America, when I was at Neuberger Berman, we were not an Impact Fund. We weren't thinking about that. Maybe we should have but we didn't, that was not a topic back then. We're purely looking for returns, which we achieved. But at the same time, all this impact was created by just simply thinking about where can you invest in fundamentally strong businesses. There are a lot of fads and a lot of strategies, trying to gain a quick win, and I'm not against them at all.
 
But when you really think about how you want to create value for 10 years, I can't tell you how Bitcoin, or crypto will develop or whether, you a certain HR software will be used in five years or not. But what I can tell you is that there are billions of people in emerging markets that are growing in population size rapidly, that will need a lot more health care, a lot more education, and a lot more logistics and manufacturing and industrial capacity over the next five to 10 years. And if we help build that, I think that is impacting of itself. And we can talk a lot about, how to label impact and how to differentiate it from traditional investing. But I think even if you forget about the impact angle for now, and you think about just traditional fundamental investing and building businesses, I think a lot of that can be tremendously impactful and has been impactful in emerging markets.
 
Jeremy Au: (14:34)
That's a great piece about separating those two ways. And emerging markets are a shortage of capital. And as a rotation capital, there's a little bit of a question for folks, which is, like, why is there a shortage? Why is there a shortage of capital in the first place? Shouldn't audit arbitrage just be automatically added or solved and arbitrage out in a single day, typing on a laptop and hit the mouse button and you're done? So what's changing to this imbalance or this arbitrage component?
 
Clemens Feil: (15:21)
I totally agree with you. And I think there should be a lot more flows into emerging markets. I think there is an I don't know if you call it arbitrage. But there's a huge untapped investment opportunity in emerging and frontier markets. And, I hope that investors will wake up to that and realize that because it's really a large opportunity. It is obviously complicated, emerging markets investing is not particularly easy. And I will now not talk about public markets investing because it's kind of its own animal. But when you look at the private returns, the private equity returns, they have not been particularly good historically in emerging markets. So that is definitely one aspect. So if you're an allocator, you're a large pension fund, a large insurance fund, and you're trying to discern where you're investing, while you are in US and Europe and tech and venture. And then you have emerging markets, which at least you perceive, whether it's true or not as high risk, but with lower returns, that's a very tough trade-off to make for an allocator. And I obviously think it's still attractive for various reasons. But when you just look at historical numbers, the returns in emerging markets investing are lower than in developed markets. So an investor might think, Well, I am not going to invest with higher risk and lower returns. And obviously, there is more truth. But that's what it seems like to a lot of institutional investors and allocators.
 
Jeremy Au: (16:54)
But why is it that returns are worse, because you just said it yourself, like so many things to build, there are schools, there are teachers, there are so many opportunities, infrastructure but so as you said all these opportunities but as I said wait returns are worse in emerging markets, so it's like what's going on here?
 
Clemens Feil: (17:14)
It's a bit paradoxical. I agree. And I've spent a lot of time thinking about that and talking with a lot of people about this topic. I agree, it's a bit of a paradox that you would expect, but there are multiple reasons for that. I think one reason is the fact that a lot of emerging markets and emerging markets impact investing actually has even worse returns. And that is a new strategy to a certain extent. So when you look at new strategies, there's a J-curve. So it means it actually takes time for the returns to come through for the value creation to happen. And if you are at the earliest stages, you don't really see that yet. So it might look like the returns aren't particularly good. But that might just be because you are in the early stages of that. So there are some aspects of that. Another aspect is scale. So a lot of emerging markets funds, our local funds, and when I say emerging markets, this China or India or Brazil, is that part of it. When I talk about emerging markets, I'm not talking about like the new emerging markets, different tier markets, so outside of China. And a lot of these funds are small and local. And they are certainly economies of scale to private equity investing. And that's particularly true in emerging markets where diligence costs are high.
 
Jeremy Au: (17:38)
So Clemens, why is it that returns suck in emerging markets?
 
Clemens Feil: (17:41)
So the key issue is scale. So a lot of emerging markets funds, and I'm not talking about larger funds in China, which now is often excluded from what we consider emerging or frontier countries. But in the newer emerging or frontier countries generally, funds are smaller. And there is a scale issue. And there's obviously economies of scale for private equity funds. Because diligence costs are expensive, especially in emerging markets, where you don't have as much access to information as perfectly as you will, typically in the United States or in Western markets. So the diligence costs would have to be spread over larger size tickets in order to be more lucrative. So there are economies of scale for that. And there's a second aspect to that actually, where local funds have the advantage of having local teams being very well plugged in, having great access to deal flow. However, they also increase the risk, because you are limited to only one country, one currency, or its currency risk, there's regulatory risk, there’s political risk. I mean, like Ukraine fund and in my first internship, we looked into investing in Ukraine, it was a very promising market after the Orange Revolution, if you're purely Ukraine fund, you can't expect an invasion suddenly to happen. So there are definitely risks to being a smaller or local fund as well. And on top of that, it often does not allow you to shift your strategy to be opportunistic.
 
So if you were a pan-regional Asia fund, you could decide, right now, Vietnam is really attractive, and then maybe, in a couple of years, it's more Indonesia, and then it might be Thailand in a few years. But if you really only focused on one country, you don't really have that opportunity and, you look forced to deploy your capital into one place. Again, it obviously has the advantages of being local, of having access to the local deal flow. But you are increasing the risk, the risk by this lack of diversification. And that is actually a big reason for the lower returns, is this layering of risks. And Professor Neil Gregory, who's a professor at Johns Hopkins business school, and also the thought leader of ICs, impact investing. And I co-wrote an article with him, that was published an impact alpha. And it was about this layering of risks where a lot of emerging markets investors, take too much risk per investment. So if you invest in one country that might be a volatile country, with a volatile currency. And an early-stage business was not a proven technology, then you have too many risks in one investment, even if you think the base case looks promising. So that is an issue as well. Part of it is also an experience problem. And there's a lot of very smart investors in emerging markets. There's absolutely no doubt about that. But many of them don't have the training and the best practices and the reps, that a lot of large-cap firms in the US, for example, have, some of them have been around for 40, 50 years, they've been through generations of best practices improvements. And some of these newer managers don't have that.
 
And finally, there's another aspect that makes impact investing on top of it even lower returning and emerging markets than the traditional emerging markets investing. And that's the issue that some investors may intentionally or maybe unintentionally, but underwrite lower returns because of an impact or perceived impact. And generally, most investors want to target market-based returns, but maybe they don't focus on it as much as a non-impact investor would. And I find that unfortunate, because if returns are low, that means, it's not attractive for investors. And there is no reason for a trade-off to be between impact investing and non-impact investing. And we can spend a lot of time talking about that as well. But if done the right way, there shouldn't be a trade-off. So the fact that empirically, returns are lower means people are doing something wrong. It means on average, investors are overpaying for assets. And that is something that is fixable.
 
Jeremy Au: (21:50)
Wow, got so many ways to go with this. So basically you're saying that emerging market returns are weak, which is fair for all these different reasons. Wouldn't this investing better like you said investing smarter, more diversified with more experience and not overpaying? Wouldn't that fix a problem? That's one and two isn't this investing in emerging markets by its nature already impact because like you said, the opportunities are schools and teachers and infrastructure, all that impact? And I see that in my daily work. Everyone's like, you're doing impact investing. And I'm like, this is what the country needs. So does that piece another subset of it is I can't help us like you implying that when you say impact investing is investing with extra steps or it could be used as a way to justify weaker returns to not be as rigorous as the earlier approach, so I know there's a lot of reaction but those were the thoughts that came out of me and my mind, when you said all of that, so could you share what you think about that?
 
Clemens Feil: (22:32)
Absolutely, I'll address them one by one. So your first question was, basically, is it fixable? And the answer is absolutely, yes. Some of those issues will just naturally go better over time. I mean, one issue is the lack of experience, or the lack of maturity of the industry, especially impact investing in emerging markets, that will naturally get better over time. The scale will hopefully also get better over time as managers grow and expand. But it also takes an additional approach, it also takes some of the more experienced managers or investors to enter this space and to bring their experience and their due diligence standards and high underwriting standards to these countries, and to also come with a diversified approach, and an opportunistic approach, where you don't just focus on one country, but you have an opportunistic approach to shifting your strategy from potentially one country or one industry to another. And that helps to diversify your currency risk and regulatory risk. And it's also a scales strategy.
 
So it's definitely fixable. And I would love for that to happen. It's currently not happening. And I can't really explain why because I find it such an attractive opportunity that is vastly unexplored or untapped. But I can't wait for that to happen, because it's extremely exciting. It will bring a lot of development impact to a lot of people and a lot of countries and a lot of communities. And it's a great segue into your next question, which was, is there even a difference, isn't every investing in emerging markets impact investment? And I would say if done the right way, almost every emerging market's growth, equity investment should be an impact investment.
 
So I think there are some extra steps, I don't find them particularly prohibitive. And I think they generally should also not lead to lower returns. I'm just taking it as one example. I know it's a little bit different. But then in developed markets impact investing, impact investing in traditional investing actually have the same returns, they're equal. So when you look at the recent, call it five to seven-year periods, impact investing in the USA and Europe have achieved the same 15 to 17% returns as traditional investing. So it is definitely possible to do that. And when you think about what defines impact investing, it's generally considered three things. Its additionality. Its intentionality. And its measurability. So when we start with additionality, additionality means you basically have to contribute capital and tie whatever outcomes you want to have to your investment. And that is generally achieved when you're a growth equity investor, it's harder to prove that when you're a buyout investor, because you're buying somebody else out, but as soon as you contribute capital for a company to grow, in most cases, additionality is achieved, measurability, measurable, it just means you measure whatever social outcomes you have.
 
So whether that's patients treated or you equality achieved, or emission saved, or whatever it is. And that's actually something that is now not exclusive through impact investing industry, because a lot of traditional investors are starting to measure those things, too. And I think that's actually very important. And it's increasingly demanded by LPs and allocators. And that's a good thing. So that's not necessary anymore. It's not a feature of just the impact investing industry. So then the other point is to intentionality. And that's where it's a little bit different, because intentionality means you have to be intentional about what you do, and you can't just invest in and say, Okay, we treated a lot of people that was an impact investment, you can't do that expose, you have to do the accent it. And that is a little bit of a difference. But I don't find that prohibitive, because just the same way, as you have different investment strategies, an infrastructure investor or healthcare investor, or a tech investor, nobody will say, Well, you're going to have low returns because you’re a health investor because you're missing out on manufacturing returns or whatever it is. It's just a different strategy. And I think so is the impact investing. And so as long as you intentionally declare, where you want your impacts to be, and whether that's in the healthcare space, or the education space, or the mission space, I think that makes a lot of good and thoughtful, long-term investors, impact investors if they have the right approach.
 
And in that sense, it really should not be that different from a thoughtful growth equity investor in emerging markets in the first place. And now to your next question about extra steps. Yes, sometimes there are extra steps involved. So for example, if you're investing in a pesticide company, sometimes pesticides are necessary to protect crops, if there's an increasing need to feed larger amounts of population and food security is a big problem, and a decrease in arable land. So pesticides are sometimes important. When you invest in such a company, you could have the word, now a lot of people view that ESG or the negative filter approach and say, Well, I don't want to touch that. That's not how an impact investor thinks about and impacts investor thinks, while this is clearly necessary, because there are more people and less arable land, so we need more pesticides, we can't get around it. So how do we fix it? And how we fix it means you invest in a company and you help them get up to speed on phasing out toxic materials, on sourcing more sustainably, on disposing of waste the right way, of using proper PPE, of proper hiring practices, the right HAZ methods, all of these things. And that might be a little bit annoying for the company in the short term, but in the long term, you're building a much fundamentally better company and a more sustainable company, and a company that hopefully will not be the newspapers for injuries or harmful chemicals. So that's how an impact investor thinks about and that takes time to create, but it's obviously a lot of value created. And it's obviously financial value that's created. Because if you sell such a company to another investor or take it public, there should be a lot of interest for a company that's adhering to global standards but also you're obviously creating a lot of impact to the local community. And that's the beauty of it. And finally, to your question of, is it just an excuse for bad returns? I think, unfortunately, that happens often in the industry.
 
And I think what's the impact industry in emerging markets needs is, is more discipline. And that's more discipline from investors and from their investors, the LPs and the allocators. Because I think allocators should not simply accept low returns because of impact because it has really been proven at this point, there shouldn't be a trade-off. So you have to hold your manager, you have to hold your investors to the same high standards as you hold everyone else. And so really, impact should really not be an excuse for bad returns, and hopefully, that will stop.
 
Jeremy Au: (32:55)
Well, there's a paradox/crux of it, which is impact investing, you've done well should be investing with a little bit more discipline, but you really shouldn't change the fundamental return structure. Yet at the same point of time, impact investing returns are in practice lower than conventional investing in emerging markets. So is that the real way to solve it from your perspective or you think is this not solvable?
 
Clemens Feil: (33:23)
I think it is very solvable. And the solution is really in applying higher standards and holding for investors allocators to hold their funds and their managers to the same high standards. So higher discipline and enforcing this higher discipline and not accepting impact as an excuse for lower returns. So higher discipline is definitely an edit that needs to be enforced. The other aspect is just simply experience. So that will just grow over time, at least, we would hope so. It is maturity. Like I said before, the emerging markets impact industry is pretty nascent. So as we're in this J curve, and early stages, it takes time for this value to be created. So that should also be alleviated over time. But also it goes back to the problem that I mentioned before that's just an issue in emerging markets. And it's the problem of experience. And that can also be alleviated by more experienced, funds and investors moving into the space. You've sort of seen that in the developed markets for Blackstone and Neuberger Berman and LGT and Partners Group and KKR and Bain Capital and TPG have moved into impact investing and again overall the returns show that there is no trade-off there. But that has not really happened yet in emerging markets and I wish for that to happen. I wish for all these impact funds or global managers that have really a strong talent pull and rigorous diligence and high standards to apply that to emerging and frontier markets impact investing and that has not happened yet and hope that will happen soon.
 
Jeremy Au: (33:51)
When you look into the future, you see investing in emerging markets that create a lot of impact as the future. And I think that's the picture that is starting to take shape in that future, what do you think will be the fastest thing to accelerate that future and what's the one thing that will decelerate us getting to that future?
 
Clemens Feil: (34:13)
That's a great question. I definitely think an accelerator would be what I mentioned before being developed markets investors with a strong track record and an underwriting standards and a strong talent pool to address this market. I think that will be almost the quickest fix that you can imagine. I can't fully explain why it hasn't happened yet. I think maybe there are more immediate closer to home and easier ways to achieve returns and make money, maybe that's one reason. But I think eventually it will happen. I think people will eventually wake up to this opportunity and that is a way to make that happen fast. So now what will decelerate is almost any world event that you can imagine. Because ironically, if developed markets are doing really well, and we've seen it, over the last 10 years until recently, people storm into tech and Silicon Valley, and I don't know pretty much any investing, because there's so much to do at home in the US. So people aren't really interested in emerging markets, because there's so much to do in the US. Ironically, if the opposite happens, and there's a market downturn and potential recession at risk, the first thing that people do is they don't want to invest the money abroad, they want to keep it at home. So ironically, is like almost whatever happens in the world, will be a decelerator.
 
But that just invests investor psychology, and it doesn't really address the underlying, potential, it doesn't diminish the underlying potential that is there. Regardless of what happens, there's going to be like a billion more people in 10 years that need education and infrastructure, and health care. And it's almost always short-sighted not to see that. But it just happens sometimes with investors, some investors I guess can be short-sighted. But eventually, I hope that people will wake up to this opportunity said.
 
Jeremy Au: (35:45)
And you talked about this experience gap as something that's perhaps a point of divergence between developed markets, investors versus emerging market investors. And I think there's a bit of a parallel for yourself. Because you yourself were once a junior investor and now you're a senior investor at both IFC as well as being capital. So what would you say are the biggest skill gaps that need to be addressed or weeded out or selected for as part of that skill?
 
Clemens Feil: (36:22)
I think it also goes back a little bit to investor discipline, and that has obviously multiple facets. But just purely mathematically, if one strategy is achieving lower returns than another, that can be alleviated by paying less for the assets. Or the flipside. Could be, you're simply overpaying for assets. That's just mathematical. So goes back to discipline of not overpaying for assets, not rushing into something. And it also comes with another skill that is necessary, is really fundamental and thorough diligence. And that sounds very obvious. And I thought it was obvious, but it really isn't, I've seen a lot of emerging markets investing, be thematically driven. And I don't, per se have an issue with thematic investing, because if done well and thoughtfully, that can also be a good style of investing. But there's too much of that happening and too little of fundamental investing. And fundamental investing is tough, you need to do a lot of digging and a lot of thorough diligence and analysis. And turning every table over three times and crossing every T dotting and it's hard, and it's complex. And it's obviously an additional complexity to already complex emerging markets. But especially if you're writing larger cheque sizes, and you're investing in more mature companies, it is absolutely necessary. And perhaps some investors have kind of grown with the market, they started as early-stage investors. And then they just kept going with their investment strategy and philosophy as they write larger checks and invest in more mature companies.
 
However, it is a very different style, like investing in later-stage companies is a very different investor style and approach than investing in early stage and I did the inverse of that. I can tell the story of about the inverse of what happened because I'm a trade large cap, or mega-cap buyout investor who knows more into late-stage growth, equity investing of smaller cheque sizes and more, growth companies, and you would think on the face of it. Yeah, you're trying to find a good business. How is that different? There's a lot of very different aspects to it. And, that might not have been fully recognized by some investors.
 
Jeremy Au: (37:04)
You say all these things about how it means to be a better investor, which is taking the time, paying less for weaker assets and paying more, obviously for better assets and doing due diligence, being thoughtful. And that's a very unpopular opinion. Every time I open up my email newsletters, especially in like tech and growth equity, it's like, hey, founder-friendly, you gotta move quick. I literally had a founder sit down with me. He was like, hey, if a company's going to go big then you should get in at any evaluation. Is every investor destined to be founder unfriendly based on this thing? Or, what's the sweet spot that actually makes this marriage work between founders who are building the business versus equity investors?
 
Clemens Feil: (37:40)
I think you're addressing a great point. And this really goes straight to the heart of some of these issues, is that as the company stage develops, the investor approach has to change. And a seed investor is very different from a ‘Series A’ investor, is very different from a Series B investor. And when you look at an earlier stage investor, somebody investing in a Series A and Series B, 5, 10, maybe 15 million cheques, you have to be very founder friendly, and you have to be very founder oriented, because a lot of these companies are still very founder driven. And that is totally fine. So, I'm not disagreeing at all with this approach for early-stage companies. But when you're moving into larger and later stage companies, when you're moving into 30, 40, and up to 60, 70 million cheque size tickets into Series C, Series D companies, the founder becomes a lot less important, because at that point, you're looking for proper corporate governance, you're looking at, succession and a board and a proper, C League of executives, and you actually want the founder to be a little bit de-emphasized for risk mitigation and succession and, proper leadership, etc.
 
So, the style changes, because at that point, the board and the management and the company, and the business model becomes a bit more important than the founder. And at that point, also, you have more track record to analyze, so you're not really focused as much on the track record of the entrepreneur. Because you at that point, probably have five years of finances so you can analyze and look at the actual company and extrapolate that, and if you're a Series A investor, you might not really have that or you might have just 500% growth last year and 1,000% before, it's really hard to extrapolate that but when you look more in like a steady state scenario, then the historical financial track record becomes a lot more important and more analyzable, I think those are some of the reasons why the approach changes.
 
Jeremy Au: (38:44)
So I think there's a very good theoretical view of what that means. But it doesn't feel like that happened over the past few years. I mean, in the past few years, a record number of unicorns were minted primarily due to growth equity. And now this year, we're starting to see a lot of unicorns. I don't know what happens when a unicorn goes from reverse. I think the minted, the de minted or de-horned and decapitated? So what happened here? Was it like becoming a horse? It was like, a horse of something stuck on top. So, like you said there's a lot of really smart discipline investors all walking around the table, and then somehow, it's falling apart. So was it like maybe just a broad, macro? Like, it'll be the Austrian economic site coming out? Interest rates were highly distortionary because of zero interest rates. So, everybody was rational, but it was just all rationally doing it. It was the wrong yardstick. Or is it because I think some people are saying like, growth equity investors was this muted attack game? And so this had to learn it. Or you're just saying is this due to individual fun, returns, this Darwinism, dog eat dog, cat eat cat. This is part of the process of figuring out who is a smart and who is a less smart investor.
 
Clemens Feil: (39:12)
I think all of what you mentioned has been going on and I think part of what has happened in emerging markets for the last few years in this run and all these unicorns is a lot of money has been going into tech. And that is not per se a bad thing. At this point, a lot of things are becoming tech, pretty much everything is becoming tech, healthcare is health tech, education is edtech, etc. But a lot of things have been going into pure tech platforms and have almost like missed the real economy behind it. And, a lot of money has gone into flashy companies that sound really cool. And that moves really fast. And not all of those will be successful, not all of those will be sustainable in their growth. And what has almost been neglected a little bit is the more traditional, maybe less trendy companies like manufacturing, a lot of manufacturing is now driven to India, from a lot of companies changing the supply chain from China to India to Vietnam, precision engineering, it's not low-quality manufacturing, it's high-quality manufacturing, some of these companies are growing 50, 60% a year. So it's not really what you would expect from a typical manufacturing company. So I think there are a lot of more like traditional industries that have been a little bit neglected, that might have had a little bit less of a beta, less up but also less down, just more like steady growth and, more sustainable growth in the end. So these are more the companies that I tend to focus on, these motor competence that ISC tends to focus on. And a lot of investors rushed into what I believe to a certain extent was a bit of a tech bubble, of chasing unicorns, and then a lot of those Bubbles bursting and exploding.
And it also goes back to the point that I made before where perhaps investors had their approach for series investing, which again, works really well when you're a 20-million series investor. But when you are writing 50, 60 million plus cheque sizes in a Series C or Series D, you have to change your approach. And a lot of investors did not change their approach, they did not become more diligent, more thorough, more analytical, they just kept going with the systematic approach, which, again, sometimes works, sometimes doesn't, but I think there might have been too much of this thematic investing going on and too little of this, okay, now we're looking at a $2 billion company, we're writing a large cheque, maybe we should dig more into how we can make this sustainable and put into proper board and proper governance and more sustainable financial growth.
 
Jeremy Au: (41:55)
So what's the consequence obviously, of bad investing? So, all of this we just talked about, so off the top of my head obviously, bad investing creates bad outcomes, maybe like companies grow in the wrong way or they have to do layoffs, things like that. But what do you think are the societal consequences of like, individual bad investing in a sense or systematically bad investing?
 
Clemens Feil: (42:20)
I think you bring up a really great and important point, and you bring up something that is really dear to my heart. And to a lot of impact investors, a lot of emerging markets investors, because what might happen is you're creating like a negative spiral that bad investing is creating. So if you're generating lower returns, people will think well, emerging markets are just a charity case, and they're not really going to, invest their capital there. So the local funds will stay small, local investors are not going to gain experience, returns will stay low, so you have trouble attracting and retaining talent, because if returns are low, there's not going to go, any big carrier cheque going around. So it's almost as like a negative cycle. And, that's really a tragedy. And I think that's almost what I see happening a little bit in emerging markets now, it's like, you really have to break out of the cycle of negative returns or, poor returns, leading to less capital flow, less capital flow leading to lower returns, leading to trouble attracting capital, leading to even worse returns. And so there are real negative effects from bad investing.
 
And that's not just harming their investors or their returns, but it's also harming community business, as we said before, there's so much positive development impact that is possible through these investments. And that's something that I think we all observe every day, how much you can really create simply by bringing capital here and having good returns and then attracting more capital and having more companies grow and hiring more people and attracting more talent and I really want to see this spiral going up and not down. And so you bring up a really good point.
 
Jeremy Au: (43:08)
And obviously, there's a societal contract, because I think investors get a bad rap. I see the memes and investors that are in suits, drinking wine and wearing the Patagonia, wear vest these days, especially for growth equity, folks. So what do you think is socio contract that needs to happen or needs to be underscored or highlighted because like you said obviously all investors should be good investors, if not for good a society that at least to continue having a job but also even if in that scenario what does that a range men or partnership that like.
 
Clemens Feil: (43:54)
There's a lot of philosophical thought now being brought into investment community. And I think that's a very good thing. Because people are thinking beyond simply, financial returns, but also look at broader impact that their investments have. And there are a lot of studies, even historically, that show even before we actually started caring about these things, that private equity-led companies actually grow more or hire more people and actually lay off fewer people in downturns because they're more long-term thinking. I don't want to quote any of those studies that don't have them at hand. But there are a bunch of studies to actually show positive impacts of private equity. But you always hear the negative stories because that's more sensationalist, you hear about this private equity fund that like, I don't know, strip the company dry and then sold it and still somehow made money. That is so incredibly rare.
And I'm not defending it, there are obviously bad actors in every industry there. There are bad lawyers and bad doctors and bad private equity investors that give us all a bad rap. And, so I think it's good to raise a bit of like a housecleaning going on, or first eliminating the bad actors, because they have a bad effect n people and on the industry, because they give everyone a bad rap. But also, because generally, bad private equity investment is also not sustainable. When you explain it to people who don't understand private equity. It's like, okay, so if you strip a company dry, how you're going to sell it, you only make money if you sell it for a profit. So it's actually very rare to strip an asset and still make money, it's very rare that that will actually happen. So generally, a private equity investor only makes money if you do hire more people and do have more sales, and actually grow and make it a more sustainable company in the long run. But what the industry is now trying to do is trying to say like, how can we do that, while also looking a little bit more about what effects our investment have? And can we have a more positive effect on society without necessarily sacrificing returns? And that's absolutely the case. And that's true. And there's actually positive alpha from that being created. When you just think about ESG, if you break it up into environmental, social and governance, yes, there might be some fluff around it. And a lot of like rethinking of this industry, is it worth it or is it not worth it? But if you just think about this individually, environmental diligence, maybe in the 80s, that was a hippie thing to do. Now, every private equity fund in the world does environmental diligence, just simply for risk management. Governance, a lot of companies fail simply because there is no proper governance there.
 
So yes, it's proper investing and proper risk mitigation to have proper governance. Similarly, in social aspects, that's not necessarily an esoteric concept, but if you attract the right people, if you attract a good talent pool, that means you have to create an attractive work environment that's not hostile to women or minorities, to attract the best talent to your companies. And you don't want to be the front page of the Wall Street Journal for mistreating your employees. So all of those actually really important fundamental factors that I think now are being integrated more into mainstream investing as it is because people are realizing hey, there's more to that, it's not just esoteric concepts, it's actually focuses us and forces us to think more sustainable and think more long term. And so this rethinking in the industry is having positive long term effects.
 
Jeremy Au: (44:49)
And you shared about, the growth equity fundamentals which really advocate that active approach hands-on, in terms of due diligence in terms of corporate governance, and there's also a very strong push for a passive approach. So, indexing, one is active, highly concentrated, doula work versus passive, spread it out, some people may even call it spray and pray, for the same stage. So, are you like, what an active camp or what scenarios would lean more towards one or the other?
 
Clemens Feil: (45:08)
When you say passive, there is some approach and maybe more the public investing domain on this ESG investing and ESG index funds, I have trouble really seeing the impact behind that. It might be there. I personally as a private investor, I have trouble seeing a lot of that being, really driving a lot of like positive change. So I personally think that an active approach is required to have positive impact. And this also goes back to, the example that we've mentioned before we're a more passive investor might simply say, I don't touch pesticides, because that's bad. But an active investor says, they're actually necessary. And let's actually do it the right way and make this a sustainable company. And that's how we create impact and build value. And when it comes to a spray and pray approach, this goes back to what I mentioned before about somatic investing. And I don't think that's bad per se, because in general, any dollar of growth capital that you bring to emerging markets is a win, any additional dollar that goes into hiring more people, and building more and hiring talent and building more infrastructure is a win. So if this is done for spraying approach that spray and pray approach, that's not necessarily bad.
 
But it's certainly limited because you only see the fast growing industry, the trendy ones, those that are growing fast. And, you might say, okay, e-commerce is big. So now I'm going to invest in five e-commerce companies in Indonesia. And then I don't think there's anything wrong with this investment approach. Because like I said, you are bringing new capital to these countries that is a positive thing. But you're missing out on a lot of stuff. So you're missing out on fundamental companies that might not be in those industries, or you might be missing out on this one company that's actually better than all of the others. And so I think the spray and pray approach just misses a lot. And I think that's what's happening a little bit in emerging markets is maybe too much of that happening, and too little of that finding the gems happening.
 
Jeremy Au: (47:49)
You might be excited because I think it's fair, which is, an active approach. Actually, you're making the social impact case for active investing, is a better corporate citizen and societal citizen, then a passive investing? Is this that, you are very expensive? I guess it just reminded me. So the crux of passive investing is like that board members are very expensive, that due diligence, very expensive, the returns are just fundamentally better. If you just cut out Clemens and Jeremy and all these folks, just put money in and let the team figure it out. Active versus passive has feels like the war has been won for returns perspective or passive, at least on the developed market side. Is that a feature you think of developed versus emerging markets? Like if there's a lot of information symmetry, passive or approach generally tend to be better for returns but in low beta markets or high information asymmetry markets activist investing is better? Is that how we should think about it?
 
Clemens Feil: (48:47)
Perhaps that's true. And the passive investing works for some industries, it just doesn't work for others, or it doesn't work as well. So if it works for high-growth tech, that might very well work, but it might not work for manufacturing, and vice versa. And the onus on the active investor is to justify this additional layer of like I said, additional diligence and additional, thoroughness or whatever it is, but ideally, you are creating value.
 
So if you see, for example, you investing in this pesticide company. And first of all, like I said, there are economies of scale. So if you are investing a 3 million cheque, it's going to be very hard to justify all this additional diligence and like thoroughness, because it will be hard to pay off in a small cheque. But if you're investing a 50 million cheque, then that makes it a lot more worth it. And at that point, also, creating an additional multiple or two evaluations from this value that you're creating also matters a lot. So at that point, you are helping build a better company. So you're not just relying purely on Okay, the company is executing, while the growing revenues and they're growing the EBIDA. But actually, the company will be worth a higher multiple of EBIDA dot exit, because you're doing all these like active things. You're creating more valuable companies for that. And so that trade-off definitely has to happen. And I've seen it happen. I guess always data on that, I have to dig out somewhere, but it's just some industries are more conducive than others.
 
Jeremy Au: (49:38)
Awesome, on that note, could you share with us a time that you personally have been brave?
 
Clemens Feil: (50:49)
It's a great question. A few years ago, I would have probably said, coming to America, because I grew up in Austria, and I didn't know anyone here. And I didn't have a network or like professional advice here. So that was a bit scary at first. But now I would probably say it was moving into growth, equity, development, finance, or investing with impact and leaving Bain Capital. I think that was a tough decision to make, it's like are you willing to, at least in the near term, forego some financial upside for following your heart and following your passion. And that's what I chose. So hope that was brave.
 
Jeremy Au: (51:20)
And if you had a time machine to go back 10 years and time, when you were just starting out as an investor and hit a time travel machine to see yourself, get you to buy yourself a cup of coffee, what advice would you give that you miss out for yourself?
 
Clemens Feil: (51:33)
I do think it is important that you do what you enjoy doing. Obviously, you have to make enough money to sustain your life and feed your family and get your kids into a good school. But in the end, I don't think you should be doing anything that you hate, where you just can't wait to go home and just look forward to the next vacation or worse to retirement. I think you do have to do something that gets you out of bed in the morning that excites you and if I won the lottery really big and had a lot of money at hand, I would still be doing exactly the same thing I'm doing now because I really really enjoyed doing it. So maybe I would just go back and tell myself that same story and make myself feel better about the decisions that I made. I do think it is really important to do something that you genuinely enjoy doing.
 
Jeremy Au: (51:51)
Thank you so much, Clemens. So, I love to kind of like summarize the three big themes from this conversation. The first of course, is thank you so much for sharing about, developed versus emerging markets, like Southeast Asia in terms of returns, and the dynamics that drive weaker returns. For example, from experience a skill to diversification. I think that was really a masterclass, really of sketching out the landscape about what's going on and why it's not being arbitraged or fixed, immediately. So the second is really about the paradox of impact investing. So, on one hand, I think we can look at impact investing as investing with a thoughtful eye yet not necessarily, huge trade-offs or any trade-offs on the returns profile. In practice, impact investing has been weaker in emerging markets. And that was a very sobering yet, I think frank discussion because there are so many people who are really rooting for impact investing, but also, honestly disappointed about how it's going as well. Lastly, thanks for talking about the fundamentals of growth equity, obviously, about how investors are learning the benefits of active versus passive approach, but also the skill set and mindset changes that needs to be done, for example, entering new verticals, technology or hatchery or whatever it is, as well as like, the new mindset needed to enter new markets, like emerging markets and other industries. So, on that note, thank you so much for coming on the show.
 
Clemens Feil: (52:47)
Thank you, Jeremy. Appreciate it. Thanks for having me.