The Indian private equity has been a favourite whipping boy for sometime. Many funds have not been able to raise money mainly because LPs or limited partners -- who invest in such funds -- think the Indian PE funds have not been able to produce the returns that have been promised nor have they been able to return much money to the investors. Besides, some of the other markets like China and Australia are looking much more promising than India, resulting in a limited LP exposure to India.

Is this criticism fair?

Probably not. After all, it was the LPs' "expectations" of returns than the actual returns delivered itself that is hurting them the most. LPs pushed the Indian PE much beyond it should have been, based on their top-down view of the market (a promising macro story, which also went down the drain, more on that later). Consequently, there are LP portfolios to be seen comprising eight to 10 PE funds ranging from bets in funds which invest in early-stage ventures to those who make late-stage investments. It appears that LPs essentially pursued a "spray and pray" strategy - something commonly followed by early stage VC investors. While the rationale behind increased diversification is to reduce risk, more often that not - “wide diversification is only required when investors do not understand what they are doing”- in the words of Warren Buffet.

The Indian private equity has been as good or as bad as any other PE market. For instance, finding exits are getting difficult even in China -- a market which has always wowed Asian LPs in particular.

A Wall Street Journal report suggests that private-equity firms operating in China received $2.1 billion in the first half of this year from the sale of investments, less than half the amount in the same period last year, quoting Hong Kong-based Center for Asia Private Equity Research. Also, a quick data pointer from Coller Capital suggests that India has not performed so poorly. In fact, the performance is above average in terms of fully realised IRRs. As of June 2010, India delivered fully realized IRR of of 32.6%, higher than that of South-east Asia (14.4%), China's (30.4%) lesser only than other developed economies like Australasia ( 50.2%).

Of course, in terms of overall IRRs, India's (9.9%) has a long way to catch up with China's (21.8%) especially when both the markets took off at the same time from an institutional market point of view.

Also, in PE or any other investment industry for that matter, there can only be a few winners and not that all will do well. There have been a few fund managers who have made money for LPs (and for themselves too): some of the prominent ones include Ashish Dhawan, Ajay Relan, Rahul Bhasin et al. One thing common to all of them was that they all had made several missteps, helping them learn and emerge stronger. So, more than the PE story itself, it is the hypothesis that anyone and everyone can make money in a benign market that has failed.

And even if LPs feel that cash distributions done to them is far and few in comparison to the quantum of monies that they have put in till date, is it fair to lay the complete responsibility on GPs for a bad PE showing? Just like it's unfair for a PE investor to blame the entrepreneur or the enterprise for the poor returns made on an investment. This brings us to a natural question on due diligence.

Now, if one were to look back at the composition of the PE fund managers who raised money in the go-go days, they were professionals mostly drawn from either operating corporate backgrounds (who held senior managerial positions at firms like Birlas, Tatas or such family owned enterprises) or investment bankers who got together on their return to India to form a PE fund and were lucky enough to quickly raise commitments during the ‘India mania’. The bottomline is that there are not enough fund managers who have seen one complete cycle. Perhaps, this explains why deals were done at very high entry valuations - one of the major woes taunting the Indian PE industry.

It's certainly not about blaming the LPs either -- it's just that the perception that everyone could make money in a growth market was a false one. The good news is that LPs are now becoming highly discriminating and investing in funds which can provide them with a differentiated exposure or those which are not a me-too game and ensure better returns. While LPs are taking tough decisions after having gone through one cycle of their not-so-happy investing experience, are PE funds introspecting?

A recent Private Equity Barometer report (a semi-annual global private equity survey) by secondaries private equity firm Coller Capital noted that GPs not learning lessons from the past was the biggest risk factor in the minds of Asia-Pacific LPs for making further commitments in the region. Some of the obvious lessons LPs commonly refer to are: monitoring entry valuation, hedging against currency fluctuations, preparing for an 'exit' from the start, under promising & over-delivering and most important, returning capital back to the LPs if not put to 'good' work.

But are these lessons being taken seriously? Private equity is essentially a people business where more often than not money goes away with people. Shouldn't GPs now think of building their businesses like institutions in the same way they advise portfolio companies?

A one-man show kind of franchise doesn’t make sense either. A case in point is a home grown PE fund with a billion dollars in assets under management until one day its chief met with an unfortunate demise. The firm had to be put up for sale.

Institutions-like PE structures seems to be the natural progression for PE firms particularly when industry has been hypothesising that there is no room for so many players and that a hyper-competitive environment has distorted pricing leading to auction sales.

Treating the industry as a club anymore will only lead to its extinction. With one cycle coming to a close, it’s now time for PE funds to do a 360 degree assessment of their set-ups and take some bold decisions: to let go of people who defend and extending past failures and bring up those who could position for rapid, profitable growth when the cycle turns up.

Yes, an upcycle. Because it’s not all gloom and doom even though the macro environment looks very challenging: India's economy is growing at its slowest pace in nine years, the rupee is the worst performing currency in Asia this year, inflation remains high, industrial production has stalled and the country faces the threat of having its credit rating downgraded to junk. Rating agencies Standard and Poor’s (S&P) and Fitch Ratings Inc. have already lowered India’s outlook on a slew of economic concerns.

However, at a micro level -- the weak IPO market against the backdrop of slow growth and high interest rate environment over the past year will lead to quality deal flow to investors. While Indian promoters are very smart especially when it comes to valuation negotiations, there are companies resorting to raise money via PE route, especially those who were seeking to raise funds via public float. For instance, Mumbai-based AGS Transact Technologies, an ATM machines service provider, which had filed for an IPO in September 2010, resorted to raising $33 million nine months later from TPG, a US-based PE fund. Similarly, Avantha Power and Infrastructure, which had earlier filed for an IPO in March 2010 to raise close to $278 million, raised only $76 million in its second round of PE funding in July 2011 from a host of investors led by private equity major, Kohlberg Kravis Roberts and Co (KKR).

No one can pinpoint the precise mix of reasons why PE firms succeed or fail? There is no magic formula, only a long list of known ingredients. PE players have to do relationship driven deals, desist from paying a higher entry price and ‘value-add’ in the true sense, apart from institutionalising the set-up. They have to be also bold enough to return the money to the LPs.

Whatever be the prospects of PE, $50 billion invested till date is no mean number. There are countries whose GDPs can tangibly move up and down with this kind of figure. It's time to get accountability back!

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