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Industry future uncertain amid inflation fears

Europe’s private equity industry is heading into choppier waters, according to a leading academic.

Laura Tyson, Dean of the London Business School, warned at a conference today of a marked deterioration in the financial conditions that have buoyed the asset class’ performance in recent years.
 
Tyson, delivering the keynote speech at the annual symposium of the European Venture Capital Association in Monaco today, said: “For the first time in 15 years the central banks are all tightening ahead of concerns about inflation. It is a different collective attitude and there is a worry that the banks will go too far too fast. They are uncertain about what to do and they could make a mistake and slaughter the goose that laid the golden egg.”
 
She said there was also a danger the central banks would over-react or that their pre-emptive measures would not have the intended effect. Citing a precedent in the US, Tyson said: “In 1994 the Federal Reserve moved to check inflation, by increasing short-term interest rates. However, long-term rates went up as well and there was a significant correction in the bond markets.”
 
She said concern about inflation rates was heightened in the US by a change in the Federal Reserve chairman. There had been three changes in 27 years and each time they had been accompanied by significant market corrections.
 
Rising interest rates would mean a higher cost of financing for the industry and would hit returns fuelled by historically low short-term interest rates and buoyant exit markets. Gemma Postlethwaite, vice president at data provider Thomson Financial, said the European industry had enjoyed a record year in a presentation of final performance and activity figures for 2005.
 
Europe’s private equity and venture capital firms raised an all-time record €72 billion ($91 billion) in 2005, one and half times as much as the previous peak in 2000. They invested a total of €47 billion, also setting a new record – albeit one of more moderate growth compared with the €37 billion invested in 2004. The industry’s performance had begun to recover from the bubble years with all private equity funds returning 10.6 percent net of fees and carried interest and a money multiple of 1.39 times the original investment.
 
But Postlethwaite also questioned whether this performance was sustainable. She said managers in the US were already cautioning investors to expect lower returns given the surge of capital entering the market.
 
Tyson said economic fundamentals for the industry remained sound and, as managers of profitable change, opportunities still exist for the industry in tackling climate change and investing in emerging economies.