Value creation capabilities are used progressively more as a benchmark for LPs to select managers as its importance in driving returns increases, according to Linbo He, head of private equity at the China Investment Corporation, told delegates at the Private Equity International Value Creation Forum 2014.
He emphasised that his comments represent his own views and not those of the institution.
“Value creation and operational improvement will step by step play a much more important role rather than other [tactics] such as timing or financial engineering,” He said in his keynote speech in Shanghai.
Multiple expansion, which is an uncontrollable variable, has played a large part in the success of China’s private equity market, He explained, adding that financial engineering, which can be controlled, has been less important for firms due to the limited use of leverage.
Value creation is the most important way GPs can make a substantial impact in their portfolio companies, he believes and as a result, “Value creation will play a bigger role and become a very important benchmark or indicator for us to compare private equity funds,” He added.
“For institutional investors such as insurance funds, sovereign wealth funds and endowments, we define ourselves as financial investors or LPs so don’t involve ourselves in the running of individual companies. So when we select GPs, the ability to improve the performance of portfolio companies is a very important, if not the most important, factor.”
He praised the private equity asset class’ ability to “increase returns while reducing volatility”, pointing out the “very noticeable premium” US private equity has offered over public markets.
However, he added that research studies have shown that operational improvement can contribute over 60 percent to returns.
“We can see [value creation] has a very obvious positive impact,” he explained, “[it] will become the core competitiveness of leading PEs.”