Fundraising Special: A risky business

Private equity groups are hoping for a better year on the fundraising trail in 2013, as global investors start to seek out better returns from their investments, writes Simon Meads.

More than five years into the financial crisis that has claimed banks and insurers for its victims, as well as private equity firms, pension funds and asset managers that poured capital into the safest havens to protect from further shocks and falls, are looking for higher-returning investments that can bolster their lacklustre portfolios, held back by low yields from fixed income.

Equity markets have soared to levels not seen since the start of the financial crisis, despite persistent concerns about the future of the euro zone and the fiscal health of many developed economies. The Dow Jones index reached an all-time high in early March, just days after US President Barack Obama signed into effect stinging budget cuts, and the FTSE 100 followed suit by hitting its highest level since the start of 2008.

Adding to the growing sense of optimism, the VIX, an S&P 500 volatility index that is sometimes referred to as ‘the fear gauge’, has fallen to its lowest levels since the start of the financial crisis – around 12 points at press time, compared with over 80 points at its peak in late 2008. Many in the private equity industry – particularly within the

Risk is back on the table more so now than it has been in the last few years

Jeff Eaton, Eaton Partners

advisory community – are interpreting these figures as proof that investors want more risk. And they believe this can have a beneficial impact on the amount of capital flowing into the buyouts business. 

“By no means are we anywhere [near] back to the risk appetite people had five or six years ago; but risk is back on the table more so now than it has been in the last few years,” says Jeff Eaton, partner at placement agent Eaton Partners.


Private equity firms raised $265 billion in 2012, according to data from Private Equity International’s Research & Analytics division. That’s a $25 billion increase on the previous year – though it’s barely more than half the $512 billion raised in 2008, the last year before markets tumbled.

It’s not just that returning risk appetites can help boost fundraising. It’s also that the meteoric rise in share prices – the Dow Jones and FTSE 100 are up 16 percent since mid-November – could mean large investors push more money into private equity because of the so-called denominator effect, as they seek to balance their asset exposure.

“If equity markets remain robust, people all of a sudden become under-allocated to alternative investments, so they have to put more money to work,” says Eaton. “That gives us another reason to be positive.”

It’s a stark contrast with the end of 2008, when slumping share prices pushed down the value of investors’ equities portfolios – making their private equity portfolios more valuable in relative terms and pushing many past their target allocations. 

Eaton believes there is a six-month time-lag before the higher valuations on equities will force more money into private equity, although others believe it could take a bit longer to alter investors’ long-term decisions.

“If equities continue to perform as they have over the next year, when people are thinking about their 2014 allocations to private equity, they could easily be larger,” says Richard Anthony, senior managing director at Evercore, leading its fundraising group.

Trying to sell a private equity ‘jam tomorrow’ story against those double-digit gains in equity markets with liquidity is a bit like pushing water up a hill

Billy Gilmore, Scottish Widows Investment Partnership

However, soaring share prices can be a curse as well as a blessing; convincing pension funds to tie up their money in illiquid private equity when stock markets are performing so well can also be tough.

“Trying to sell a private equity ‘jam tomorrow’ story against those double-digit gains in equity markets with liquidity is a bit like pushing water up a hill,” says Billy Gilmore, head of private equity at Scottish Widows Investment Partnership. 

The issue is compounded by the fact that private equity portfolio valuations for end-December are still to come through in many cases, leaving investors comparing today’s stock market valuations with end-September or even end-June 2012 valuations for private equity – which were generally lower than they are today.


But while increased appetite for riskier investments may benefit private equity as a whole, investors’ laser-like focus on performance is concentrating money with the very best managers with the best strategies – and reducing the flow of capital to the rest. 

“2013 could be one of these years when you see the contraction in size of footprint of some of these larger funds. Times have got tough and you have to cut your cloth,” said George Anson, managing director at fund of funds manager HarbourVest Partners. 

Some have battled their way to target; among the large firms, Cinven held a final close in March on €5 billion after two years on the road. But Permira reduced the size of its latest fund to €4-5 billion from an initial €6.5 billion, after 18 months courting investors, while Nordic Capital also cut its fund target to €3 billion from €4 billion. Sources also suggest that Apax Partners may close on less than the €9 billion it was originally targeting.

Times have got tough and you have to cut your cloth

George Anson, HarbourVest Partners

While reducing fund size or missing target will be seen as a climb-down in some quarters, it’s better than not managing to raise a fund at all – a fate that befell Duke Street and AAC Capital in Europe last year. Any sort of close at least gets firms off the resource-sapping fundraising trail, and allows them to re-focus on their core business of doing deals and generating returns.

“We have talked to some groups and said we want to see them stay with a smaller fund. If you look at how they generated their returns, it was with funds of a smaller size,” Anson said.

In 2013, there are going to be some 2,000 funds on the road, seeking around $1 trillion in new capital, according to placement agent Triago. Since investors are expected to commit $300-400 billion a year to the asset class for the next few years, something has to give.

Simple economics also mean that the very largest investors will continue to get reduced rates for sizeable commitments to many funds, or special separate accounts on different terms.

“The headline fee for a standard pooled product is now very different from the reduced fee for very large investors, or people who are able to allocate money to a private markets manager for a long period of time,” says Alan Mackay, chief executive of fund manager Hermes GPE.

Although that could disadvantage smaller investors, management fees are lower than at the fundraising peak: 1.5 percent is becoming the norm, while first-close discounts and co-investments are providing ways to reduce this further.

Co-investments accounted for about 3 percent of money in private equity before the crisis, estimates Mackay, but their popularity is on the rise. “I can quite easily see the industry getting to 80 percent in funds and 20 percent in co-investments by the end of this decade,” he says. 

I can quite easily see the industry getting to 80 percent in funds and 20 percent in co-investments by the end of this decade

Alan Mackay, Hermes GPE

Based on Triago’s estimates, if the amount of capital flowing into private equity annually were to stay at around $300 billion, that could mean an additional $75 billion of capital available for deals that wouldn’t pass through traditional private equity funds or be subject to management fees.


The rebound in the US deal market in 2012 has spilled over into 2013; the proposed $24.4 billion Silver Lake-led buyout of Dell would be the largest deal since the crash. Hot debt markets are fuelling buyouts; confidence is returning to the economy, and successful exits are allowing GPs to distribute cash to investors, which is then flowing back via new fundraisings.

“It seems that more money relative to other areas is flowing into North America,” says Eaton. Funds raised for the US rose 10 percent last year to $79.2 billion, according to PEI data, while firms with a global remit (most of which are based in the US) raised $118.1 billion, up 80 percent, sucking money out of a European market that was seen as too risky last year. Of the largest funds currently in the market only Apax, CVC and Permira are based in Europe – and they have been increasingly focused on deals in the US.

But a contrarian view is emerging – that as fears about a euro break-up recede, the time is right to invest in Europe.

“We have very smart North American LPs looking to commit to Europe,” says Eaton. “Maybe there’s an opportunity to buy good companies at cheap valuations.” In particular, some are eyeing Nordic markets, which performed strongly throughout the crisis (and come highly recommended; a recent Economist report named Sweden, Denmark, Finland and Norway as the top four best places to do business in Europe).

However, some in Europe are starting to wonder whether an asset bubble may be developing in the Nordic region.
“There is a lot of money has been sucked into Scandinavia and you have got to conclude that will have a negative impact on returns in due course,” SWIP’s Gilmore said.

That’s leading some private equity firms to hunt for new companies further afield. For instance, Trilantic Capital Partners, the former buyouts business of Lehman Brothers (which will see its investment period expire later this year) is targeting Southern Europe, where it believes it can find undervalued businesses more focused on exports than hard-pressed local consumers. It’s hoping that forward-thinking investors, including funds of funds, will follow.

“I would like to think in the course of 2013, the early-bird global investors will underwrite the funds that are fundraising with a pan-European strategy, and through that they would probably be over-allocating to southern Europe and allocating a little less to northern Europe,” says Trilantic’s European chairman Vittorio Pignatti-Morano. 

For Asia, which saw fundraising fall in 2012 by 26 percent, the market is expected to remain tough. Investors will continue to back large brand names funds – like KKR, which is raising a $6 billion vehicle – but are waiting for funds already committed to turn into deals and for returns to pick up.


The imbalance between the number of funds in market and the total capital available, which is creating pressure on fees and driving the growth of separate accounts and co-investments, is also shaking up the industry in other ways.

Duke Street has been the most high-profile example of a firm that has given up trying to raise a blind-pool fund and switched to a deal-by-deal financing model instead. But while this may have been driven largely by necessity, for other firms that are starting out it can actually be a conscious choice – a way to build a reputation. 

“We have seen newer groups that would typically be first time funds reflecting on the market and thinking a smart way in this environment to access capital and build a track record independently is to start out as a deal by deal group,” Evercore’s Anthony says.

I think the model of fixed life limited partnerships have really proved their strength over time

Katja Salovaara, Ilmarinen Mutual Pension Insurance Company

Demands for better liquidity and better performance from investors have got some firms thinking about listed vehicles, funds with a shorter (or longer) life, or evergreen funds that raise money annually and have no end date.

“I’m pretty sure that there will be some new models [to] emerge from this crisis,” says Antoine Drean, chairman of placement agent Triago. “The industry is a pretty mature one and it is time for more innovation and new strategies.”

However, few such structures – like Altor’s 15-year fund or General Atlantic’s evergreen model – currently exist. And established investors have grown used to the 10-year closed-end funds that remain the vehicle of choice.

“It is such a big and broad asset class that there is room for different types of structures, but I think the model of fixed life limited partnerships have really proved their strength over time,” says Katja Salovaara, senior portfolio manager at Finland’s Ilmarinen Mutual Pension Insurance Company. “It’s not perfect, so that’s why you have investors complaining about secondary and tertiary buyouts for good reason. But the structure is one of alignment.”