Perspectives 2018: Troubled by valuations

Dutch tulips in the 17th century, the internet-heavy Nasdaq of the 90s and the US MBS market in the late 2000s. All distinctive, yet characterised by one major trait – historically high prices. What goes up, most certainly in these cases, comes down. It is reasonable enough, therefore, that investors rank extreme market valuations as their largest macro cause for concern in the private equity space.

Our PEI LP Perspectives 2018 Survey finds that record high valuations is the issue at the forefront of investors’ minds, followed by increasing availability of leverage and the impact of rising interest rates.

Valuations in US private equity transactions as a multiple of EBITDA reached new highs in the first six months of 2017 at 13.7x, as debt markets remained fluid, according to a report from valuations firm Murray Devine.

As one concern remains constant, another changes direction. In last year’s LP poll, investors were concerned about the low interest rate environment. Now, the worry is the impact that tightening monetary policy and rising interest rates may have on portfolios. The increasing availability of leverage is a new concern on the list. Many investors are fearful of extending loan periods.

LPs remain committed to private equity, with 46 percent of respondents intending to recommit to existing managers in the next 12 months, and 36 percent planning on forming new fund relationships.

Distressed debt is the strategy of most interest, with 20 percent looking to increase their allocation to the space. Twelve distressed debt funds have held a final close so far this year, raising an aggregate $39.34 billion, according to PEI Q3 2017 fundraising research.

The average commitment size varied widely among respondents, leading to differing results about their ability and willingness to access the asset class in various ways. For instance, 18 percent of the LPs surveyed had an average commitment size of over $100 million, which correlates with the 14 percent that have a defined allocation to invest directly. Investors are more likely to have a defined direct investment allocation across private real estate, infrastructure and private debt than private equity.

Some 40 percent of respondents were underweight in their target allocation to private equity, a consequence perhaps of the 31 percent that have found it harder to source investable opportunities over the past 12 months. That may seem like a
high percentage, but is lower than the percentage that said they had struggled to find real estate and infrastructure openings.

PEI Perspectives 2018 suggests investors have been satisfied with private equity performance over the last 12 months.

Thirty-two percent saw performance better than internal benchmarks, while 52 percent received returns in line with expectations.

As to whether this performance will continue, 29 percent are less confident in performance over the coming 12 months, compared with 19 percent who believe returns will improve.