Exit environment could hurt investor returns(2)

Private equity investors believe they’ve never had it so good, according to a new report. But is there a cloud on the horizon? James Taylor reports.

Private equity investors are delighted with their returns from the asset class in the last year but worry that they may be peaking, according to new research by secondaries specialist Coller Capital.

The results of the firm’s Global Private Equity Barometer, produced twice-yearly, suggest investors are optimistic about the coming year, but unsure whether the bumper returns yielded by the asset class in recent years are sustainable.

Certainly the short-term view is positive, however. Perhaps not surprisingly, given the strong performance of the industry in recent years, an impressive 97 percent of investors said they were happy with their returns from private equity over the last 12 months. Indeed, 56 percent described themselves as “very pleased” – more than three times as many as in 2004.

As a result, investors plan to pour even more money into the asset class in 2007. Around half are expecting to increase their private equity allocations in the next year, up slightly from 43 percent in 2005. There seem to be no concerns that the industry will run out of deals – in fact, 43 percent believe that buyout firms will actually increase the pace of their investment next year.

The consensus view is that Asia-Pacific will be the most fruitful area for buyout funds, though as always, investors tend trust the areas they know best – European investors felt Europe would offer the most opportunities, for example.

This means that almost half of investors – about 10 percent more than last year – are expecting returns to top 16 percent in the next three to five years.

But the results also sound a note of caution about the sector’s longer-term prospects. Over 40 percent of investors expect the private equity exit environment to deteriorate over the next couple of years. This perhaps explains why opinion is divided over distributions, which have been consistently strong in recent years. About a third expect them to increase, while a quarter believe they will slow down.

The results show that investors are continuing to trim their portfolios. The proportion of limited partners who have chosen not to re-invest with existing general partners continues to increase – 76 percent have declined requests to re-invest, up from 45 percent in 2005.

However, the success of all these investors will ultimately come down to their ability to pick the best-performing funds. And with so many funds in the market over the last year, it is increasingly difficult for investors – given their finite internal resource – to assess the huge number of funds being marketed to them. Investors believe that if they can keep an experienced investment team together, they will be more likely to make good decisions. Over 90 percent said this was crucial to their success – even more so than the size of the team, according to the survey.
The survey also revealed that investors believe the UK has taken over from the US as the world’s most favourable environment for private equity.