The not-so-mature Indian private equity industry needs to turn inward and reorient themselves toward the future, feel industry experts.  This has become much more relevant in the current economic environment, which has changed drastically, and the PE fund managers have to wrestle with significant new realities, they add. 

“The way we look at our business has to change. And the bar of sophistication in this industry has to go up. The environment has changed upon us – permanently, in my opinion – and if we don’t change, we will all become extinct,” said Rahul Bhasin, Managing Partner at Baring Private Equity Partners (India) Ltd, at the recently concluded VCCircle India Limited Partners Summit in Delhi. 

From an LP perspective, the evolution of the Indian GP community not only means managing the portfolio companies well but also becoming more sophisticated in all other areas – be it hedging the rupee depreciation which can become a huge macro override in their returns, getting ex-CEOs as operating peers, moving to new capital structures and strategies or distributing the carry more proportionally within the team to retain team members. It essentially means doing everything to ensure the drivers of return in the 'new' environment.

It is also clear that the balance of power has shifted towards the returns-conscious LPs who are now asking difficult questions while India being the second fastest growing economy in a growth-deprived world is not of much help either.

“Private equity is not only about a great market opportunity. You might be investing in a huge market with some 300 fund managers and not make much good returns. On the other hand, you may make better returns investing in a smaller market with a few fund managers who are consistent and know what they are doing,” said Anand RP, investment director of Squadron Capital, a fund of funds headquartered in Hong Kong with a decent exposure to Indian private equities. Anand went on to say that even in the vintages like 2006-2007, there were other emerging markets where some managers outperformed their peers and returned over 35 per cent IRR.

Mid-teen Return Not Exciting Enough

So what is the ideal kind of return that LPs are looking at from markets like India? According to Achal Ghai, Managing Partner at Avigo Capital Partners, an SME-focused mid-market PE firm, "A 15-20 per cent dollar return should be reasonable."

This might appear as reasonable returns, given where we are in the cycle. However, LPs choose to disagree. "A high teen kind of returns may not really be extremely exciting for a foreign LP to come here and put money to work in India," said Anand RP.

The sentiment was reinforced by Kelvin Yap, vice-president of HarbourVest Asia and moderator for the panel titled 'Indian Private Equity Through An Entrepreneur's Lens : How Region's PE Stands To Benefit From Macro Opportunity & Powerful Entrepreneurship', “PE fund managers need to realise that they are fighting for the same dollar that can go to any part of the world. I have seen some great returns coming from more developed parts of Asia where we have invested a lot.”

What Happens To The Best & The Rest

This, however, does not mean that Indian PE industry is losing its sheen. Given the attractiveness of the India growth story and the fact that there are a lot of good quality companies here both in the public and the private market space, there will be allocations from institutional investors in these markets. However, they will cherry-pick the fund managers.

"The best and the rest will be beaten out and it has already started. That differentiation will become even clearer in the next two-three years. Many good GPs will get a lot of flexibility from their LPs. In five years from now, 5-10 fund managers from India will be getting completely over-allocated," Anand Prasanna asserted.

The point is that PE fund managers need to learn that long-held assumptions and complacencies can and will fall apart in a subprime minute. "LPs don’t care about how well your companies are doing. They care about how well your IRRs are doing. First, we have got to understand that we are managing investment dollars as fudiciaries and we have got to generate returns. For those who will re-invent themselves and their business models according to the environment, there are a lots of opportunities," added Bhasin.

“LPs who will not get returns what they have underwritten and GPs who have taken some sub-optimal decisions will soon realise that LPs have a long memory,” concluded Yap.

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