No more alternatives

Private equity's trials and tribulations this year are far from the end of the world, writes Andy Thomson.

Andy Thomson

It might be understatement to suggest that private equity has had a testing time this year. Pause to reflect on some of the defining themes and it’s possible that your mind will form a nightmarish vision of the industry’s four horsemen of the apocalypse: banking collapse, deal drought, economic decline and snarling opposition. For private equity and other alternative investments, is it the beginning of the end?

Hardly. According to Russell Investments’ latest Alternative Investing survey, pension funds, endowments and foundations in North America, Europe, Japan and Australia are all planning to dedicate significantly larger sums to alternative assets including private equity in the next two years. Indeed, the only alternatives strategy predicted to remain steady over this period rather than grow is Australian institutional investors’ mean strategic allocation to hedge funds.

In a private equity context, investor enthusiasm appears to be driven by continuing confidence about returns in spite of the best efforts of the doom mongers to sow seeds of doubt. Indeed, private equity is expected to deliver stronger returns over the next two years while hedge fund and real estate performance is expected only to be steady. Mean return expectations for private equity worldwide range between 8 percent and 13 percent, with North American and European respondents to the survey expressing the greatest optimism.

Perhaps one cause for concern highlighted by the survey is the extent to which investors have ramped up their exposure to leveraged buyouts – the part of the market currently facing the greatest challenges (in North America, for example, LBO funds represented 71 percent of total commitments this year compared with 57 percent in 2005). However, investors appear to be taking the view that this is nothing a bit of proactive portfolio management can’t fix: high hopes are expressed for venture and secondaries funds, for example.

The overall impression is that, far from being the beginning of the end for private equity and other alternative assets, it’s the end of the beginning. As Russell managing director Jon Bailie puts it: “Describing the use of private equity, hedge funds and real estate as ‘alternative’ is increasingly a misnomer in today’s sophisticated investment environment. [The] survey highlights systematic use of these strategies to enhance returns, reduce volatility and improve fund governance through diversification.”

Alternatives have gone mainstream.