Perspectives 2018 North America: Signs of distress

There is a distinct sense of unease among North American investors in the PEI LP Perspectives 2018 Survey: 39 percent are less confident about private equity returns in the coming 12 months.  And just 8 percent feel more confident, considerably below the global average of 19 percent.

A sizeable 32 percent of North American respondents are planning to decrease their target allocation to funds of funds over the next 12 months – compared with the global average of 24 percent. This could well be a reflection of a more mature institutional investor landscape, with a greater number of LPs having built up the necessary internal resource to select funds and manage their portfolios.

Distressed fund strategies are experiencing the greatest rise in allocations over the next 12 months, with 23 percent of North American investors planning to increase their exposure to this strategy. This is reflected by the fundraising environment.

Certainly one contributing factor to the fundraising success experienced by Apollo Global Management, which this year closed the largest private equity fund ever on $24.7 billion, was the firm’s perceived ability to “flex” between benign economic conditions and periods of distress. The firm has told investors that up to a quarter of the new mega fund will likely be invested in distressed opportunities.

Over the past 18 months, Cerberus, KKR and Bain Capital have raised $3 billion-plus vehicles with at least a partial focus on distressed companies.

The PEI Perspectives 2018 data show that 33 percent of investors found it harder to source distressed opportunities over the past 12 months.  In fact, it was only fund of fund opportunities that North American LPs found easier to come by, with investable venture, growth, buyout and secondaries funds all considered more difficult to source. For secondaries, only 9 percent of North American LPs said they have a defined allocation in the next 12 months versus 72 percent who will invest on an opportunistic basis.

One deterrent is prices, with secondary stakes sitting close to all-time highs at an average of 96 percent of NAV, dampening potential returns.

In September, Brady Hyde, then private equity portfolio manager for the UPS Group Trust, told PEI the pension was seeing heightened competition among secondaries buyers – exacerbated by more widespread use of leverage – that had pushed up prices. This had put it off from buying stakes recently, but, said Hyde, “we still view secondaries as strategic in our portfolio in terms of mitigating the J-curve and getting some unique exposure”.

The impact of rising interest rates is one of the top three issues for investors in the region, with 34 percent viewing the tightening of monetary policy as a big concern.

They may take some comfort from the installation of a private equity insider in the form of former Carlyle exec Jerome “Jay” Powell as chair of the Federal Reserve. Powell is viewed as a continuity candidate following on from Janet Yellen who has largely taken a dovish approach to monetary policy.