Internal pressures

Investors believe private equity has proven its concept, according to Coller’s latest LP survey. But hostility to the asset class may now be coming from unexpected quarters.

The financial crisis has arguably provided private equity with its toughest ever stress-test. A combination of liquidity constraints, macroeconomic volatility and business uncertainty made everything more difficult for GPs, from raising capital and sourcing deals to keeping companies afloat and managing exits. Amid the subsequent slow-down in distributions, LPs could be forgiven for questioning whether the concept still had the same relevance in the new world.
It is worthy of note then that five years on, most investors think the asset class has passed the test. According to the Coller Barometer, which polled 140 LPs across a broad spectrum of institutions and geographies, 25 percent of investors plan to increase their allocation to private equity over the next 12 months – against 14 percent intending to reduce it. That is clearly linked to the asset class’ resilience: notwithstanding the effects of the financial crisis, almost two-thirds of LPs still post net lifetime returns of 11 percent or higher for their private equity portfolio.
But their loyalty to private equity is about more than just performance numbers. According to the survey, LPs are in broad agreement with how the model works in practice: 66 percent think private equity has delivered significant operational improvement at portfolio companies, while close to 90 percent believe ‘whole fund’ carried interest has proven to be an effective way to incentivise managers.

Malaysia: 30 percent of investors are willing to increase
exposure to the pan-Asian region. 

Encouragingly, a large majority of investors think the European recovery will provide fertile ground for private equity. But many are also keen to explore new strategies: one in three plans to increase exposure to credit investments in the next 12 months. Geographical expansion is also on the cards, with more than 30 percent willing to increase their exposure to the pan-Asian region – including Indonesia and Malaysia. Indeed, “this is going to have more of a focus going forward than the more established markets like China, India, Australia or Japan,” says Stephen Ziff, a partner at Coller Capital.

The survey’s findings hint at a degree of caution, however. 88 percent don’t plan to increase their allocation to large buyouts in the next two to three years; 87 percent think the overhang of dry powder is inflating prices (albeit mildly so). Most strikingly, close to 40 percent of investors at endowments and pensions say there are influential individuals within their organisation who openly display hostility towards the asset class, with calls to reduce or cancel allocations to private equity in their entirety.
The Coller report posits no hypothesis as to why this is happening. But industry insiders have their own ideas. Ziff thinks it could be down to economics or remuneration, among other factors. Graeme Gunn, a partner at SL Capital Partners, says it may be linked to the lower returns posted by recent vintages. “One of the key reasons for LP pension funds not to invest at present is because they are above their allocation for private equity. There is also an impact from performance, which has reduced if you invested heavily at the wrong time.”

So private equity may have won a battle – but it still has some work to do to win investors’ hearts and minds. “Private equity has confirmed its core place in institutional investment portfolios since the crisis,” says Jeremy Coller, CIO of Coller Capital. “However, complacency would be a mistake. With sceptics at senior levels within LP organisations, the industry will have to justify its performance again and again.”