Private equity on a roll

Institutional investors are declining to reach for the brakes as the private equity train hurtles down the tracks. Andy Thomson reports.

Given the mega-fundraising exploits of last year, in which firms began pushing sizes of vehicles beyond the $10 billion mark, it was not difficult to arrive at the conclusion that institutional investors have developed rather a fondness for private equity. What may excite or alarm, depending on your perspective, is that the asset class is becoming more popular still.

Jeremy Coller, CEO, Coller Capital

According to the latest Private Equity Barometer survey published by London-based secondaries specialist Coller Capital, 44 percent of LPs canvassed are currently planning to increase their allocation to private equity – compared with 30 percent in the middle of 2005. The trend is most marked among investors based in Europe and Asia, around half of which are drawing up plans to bolster their commitments.

Related to private equity’s growing allure is an apparent feeling that hedge funds’ attractiveness has somewhat diminished. The survey finds just 30 percent of LPs planning increased exposure to hedge funds – down from 37 percent at the mid-point of 2005.

What is also noteworthy is that investors are predicting short-term convergence between the two alternative asset classes giving way to bifurcation in the long run. Some 61 percent said they expect GPs to face “significant competition” from hedge funds over the next 12 months, but 75 percent thought it “unlikely” that hedge funds would be able to compete successfully with mainstream private equity over the long term.

If one aspect of private equity’s future is a diminished threat from hedge funds, another is likely to be the blossoming of fresh opportunities for investment in emerging markets around the world. As GPs begin exploring virgin territories, it seems LPs will happily supply them with the financial firepower to support their pioneering efforts. The survey found that more than 50 percent of LPs are planning to increase their exposure to emerging markets over the next three years – with India seen as the most attractive market, followed by Central and Eastern Europe and then China. 

Coller Capital CEO Jeremy Coller says it is in emerging markets’ best interests to board the private equity bandwagon: “At the economic level,” he suggests, “countries have a lot to play for…significant benefits will flow to those that create a receptive environment for private equity investment.” 

But while it’s possible to surmise future trends developing in private equity’s favour, it’s also safe to assume past performance is at least equally responsible for the warm feeling the asset class appears to be generating. The survey found that three-quarters of LPs were “satisfied” or “very pleased” with their private equity returns over the last year (though more than half were still disappointed with European venture). 

There’s never been such a thing as easy money, of course: investors in private equity may be loosening the purse strings, but at the same time they’re expecting more bang for their buck. Those GPs that fail to meet the high standards being set by the asset class as a whole face a greater risk of marginalisation: the survey found that 56 percent of LPs had refused to re-up with GPs over the last year, compared with just 45 percent six months ago. Investors are also expecting the already lightning-fast rate of distributions from funds to pick up still further over the next year – a heady prospect.

Equally, though, it could be argued that the net effect of an unprecedented level of LP demand is a radical shift in the balance of power in favour of the GP: the survey also found access to the best-performing funds becoming increasingly difficult, whilst the terms and conditions in some North American funds in particular were cited as a major concern by survey respondents. Private equity’s on a roll: and some LPs are discovering that’s not necessarily unalloyed good news.