How VCs and Startups can beat currency depreciation 🌍

Innovative Tactics for Sustaining Value in Depreciating Markets

Today, I’m glad to have

Timothy Motte

sharing insights on The VC Corner. Timothy writes

The Realistic Optimist

, a referential publication covering the globalized startup scene.

In this article, he interviews Robin Butler, a partner at Sturgeon Capital, a London-based VC investing in frontier and emerging market startups 👇🏻

The emerging markets conundrum

Emerging markets (EMs) have struggled to gain investors’ sustained trust. Even for the shrewd operators navigating political risk, inadequate infrastructure and low buying power, one stubborn issue remains: currency depreciation.

Many EMs, including the most promising ones, suffer from a common ailment: their currencies tend to lose value over time. And generally faster than in developed markets. 

In 2014, one USD was worth 8.5 Argentinian pesos. In 2023, it was worth over 800 pesos. 

In 2014, one USD was worth 101 Pakistani Rupees. In 2023, it was worth over 200 Rupee.

In 2014, one USD was worth 168 Nigerian Naira. In 2023, it was worth over 800 Naira. 

This poses a serious issue for investors in these markets. Their return on investment has to beat the depreciation rate. If it doesn’t, they will have lost money. If it does but only by a bit, they might wonder if the trouble was worth it. 

Yet, these markets keep galvanizing investors. The macro tailwinds are promising: vigorous economic growth, young populations and a hunger for technology. So far however, the investment vehicle that can ride those tailwinds while delivering compelling returns has remained elusive.

Most investment options in these markets remain institutional. Over the past 10 years, the MSCI Emerging Markets Index (which captures large and mid cap representation across 24 emerging markets) achieved net annualized returns of 3.01%. The S&P 500, which measures the performance of 500 large US companies, returned 12.39% annually over roughly the same period. 

The savvy investor might ask: why take a risk on emerging markets in the first place?

The EM conundrum is the following: macro tailwinds are definitely exciting, yet available investment options seem to deliver mediocre returns once adjusted for currency depreciation. Enter venture capital (VC).

VC as a way to beat depreciation

VC takes its roots in the whaling industry, a risky but potentially lucrative business. Investing in whaling meant betting on 10 whaling expeditions with the understanding that 9 would come back empty handed (or not come back), while one would bring back enough riches to net a return.

That same mentality applied to tech companies gave birth to VC. This entails betting only on companies with the potential and ambition to become industry leaders, while accepting that most will fail entirely. Venture capital doesn’t invest in stable, steadily growing businesses. It’s “go big or go home” by design. 

From 2010 to 2016, top quartile VCs delivered an internal rate of return (IRR) of 25.6%, compared to the S&P 500’s 12.2%. Those returns suggest investing in top quartile VCs is a great hedge against most macroeconomics headwinds. The key skill is picking the right VC managers.

This begs the question: can VC make the case for EM investing? Investing in winning tech companies seems to be a tangible way to ride macro-tailwinds, while potential returns beat depreciation by a mile. 

Primed markets

The case for venture capital in EMs presupposes certain conditions. The goal is to generate outsized returns that, even when accounting for currency depreciation, beat both S&P 500 and VC returns in developed markets. 

One way to do so is to fund companies that will ride EM tailwinds: growing economy, young population and increased tech penetration. The companies best placed to service these trends are tech startups. More specifically, tech startups looking to become leaders in digitally virgin local verticals. 

You want to fund the startup that will digitize all of Central Asia’s logistics companies, the startup that will digitally bank every Southeast Asian SME, or the startup that will pioneer telehealth for Africa. And you want to fund them extraordinarily early, to capture the extraordinary returns you’re aiming for. 

Identifying the markets in which these startups exist but aren’t sufficiently funded is a subtle science. Some indicators help. 

Smartphone and internet penetration above 30% is primordial. If it’s under 30%, the potential customer pool is simply too small. Once it crosses 60-70%, there is the critical mass to build digital businesses at scale.

The early presence of ride-hailing, food-delivery and digital payments apps are another great indicator. These apps don’t have to be mature, the earlier the better actually. What their presence conveys is that people use their phone for more than just messaging and social media. Tech startups capitalize on that new behavior. 

Lastly, you need at least a semblance of government enthusiasm for the topic. This enthusiasm can vary in fervor, but verbal commitment to digitizing the economy is a minimum. 

These are the markets in which venture capital makes a lot of sense. We call them “primed markets”.

---

Only for premium subscribers 👇🏻

• Operationally-speaking, for startups

• Operationally-speaking, for VCs

• The adequate founders

• Who is buying this thesis?

• Political risk

• Conclusion