Four predictions for 2011:
1.) Brazil will continue to attract capital: Over the past few years, Brazilian funds have been trying to secure more US investment but they haven’t had the local presence and relationships to do so effectively, despite strong interest by US institutional investors. Several smart investors including JPMorgan (Highbridge) and The Blackstone Group have appreciated this imbalance and purchased ownership in the Brazilian firms Gavea and Patria. These US fundraising powerhouses will likely raise billions for their new partners. Other Brazilian alternative managers are likely to follow suit and seek similar relationships. One could argue that the strength of the Brazilian economy and fundamentals is widely known and likely priced into the markets; however, the Brazilian private equity market is likely to continue to rise solely from the massive influx of new capital.
2.) Distressed investing will disappoint: Distressed funds produce returns from a combination of interest income, capital appreciation and capital events such as conversion to equity through restructuring. In an environment like 2009 when credit was trading at a significant discount to par, yields to maturity were often greater than 20 percent and capital appreciation could add another 50 percent upside. High default rates allowed debt holders to convert their holdings to equity, further increasing returns. There was a lot of low hanging fruit. The environment in 2011 will be much less attractive. The average credit is trading much closer to par which reduces yields and capital appreciation potential. Spreads have narrowed and absolute rates are extremely low. After peaking in 2010, defaults have been near historic lows. While the best distressed funds will find attractive investments in any market environment, the combination of fewer opportunities and continued inflows into many distressed funds will lead to disappointing average risk-adjusted returns.
3.) Venture interest may see an uptick: Venture capital has been the deservedly least-loved sector within private equity over the past several years due to weak returns for more than the past decade and substantial uncalled capital. Interest in venture funds could see a pickup this year as a result of strong venture exits in emerging market Internet firms, like the now-public Chinese Internet companies Dangdang and Youku.com, and Western social network companies like Facebook and Twitter, that while not public have reportedly experienced huge markups in the private markets over the past year.
4.) Fundraising will be easier in 2011: This past year many institutional investors have experienced a positive denominator effect and often positive net cash flow from their private equity portfolios. As a result, they will be more likely to commit capital in 2011, with a focus on existing relationships. The fundraising environment for private equity funds will continue to be difficult but will be much easier relative to 2010.
Sam Masoudi is managing director with the Tulane University Investment Management Office.