The financial sector might have seen through the headwind of the severe credit crisis with minor bruises, but a shakeout in the private equity industry is now imminent. Investors’ selectivity and concerns about returns will drive 20 percent of private-equity managers out of business, according to a survey by Coller Capital Ltd, a leading global investor in private equity’s secondary market – or 'secondaries' as they are called.

According to its latest Global Private Equity Barometer, about one in five firms won’t be able to raise another fund within the next seven years. The study polled 110 private equity investors around the world. This comes in the wake of the financial crisis when large investors including pension funds, fund of funds and insurers, commonly referred to as LPs, have to become more picky.

Almost nine in 10 investors expect to turn down some of the requests by private equity groups to re-invest into their next fund generation. The global financial crisis, triggered by the September, 2008, failure of Lehman Brothers Holdings Inc., left PE funds unable to liquidate investments and eroded returns for the industry. Having had time to gauge the effects of the financial crisis, the majority (54 per cent) of investors now believe that private equity is more correlated with public equities than they once did. And they now expect one in five of today’s private equity managers (GPs) to fail, the findings suggested.

This is certainly not good news for the Indian PE industry. There is already a slowdown to be seen on the fundraising front. There are more than 50 funds from India currently on the road to raise money, comprising of first-time fund managers and also the fund managers looking to raise follow-on funds. And LPs investing into India have already been vocal about the inability of the Indian fund managers in exhibiting returns on the portfolio, an expensive market for private equity deal-making, lack of experienced PE fund managers and also the recent phenomenon of Indian private equity funds being highly unstable in nature.

“Given that India is a market with a very strong growth story and one where most GPs are still fairly new, I think it would be surprising if the GP failure rate in India was as high as this in the short term,” said Hiro Mizuno, Asia Head, Coller Capital.

Fundraising remains difficult, too. A large overhang of PE capital committed during the bubble means fewer investors are able to make commitments now, and those commitments are often smaller. “However, the good news is that Asia-Pacific investors in general have fewer capital constraints than their counterparts in Europe and North America,” Mizuno added.

According to the survey, only one-fifth of Asia-Pacific investors say that capital constraints will lead them to refuse re-ups in the near term, compared with almost three-fifths of the North American LPs. 

Asian LPs To Ramp Up ‘Secondaries’

In one of its other findings, the research suggested “interest in secondaries selling has reached unprecedented levels.” Interestingly, the Asian secondaries market, which is not so developed in dealing with second-hand LP interests, is poised for an increased activity. As many as 42 per cent of Asia-Pacific LPs plan to sell private equity assets in the next two years.

Interest in the secondaries market as a tool for portfolio re-shaping is visible too in investors’ buying intentions – around one third of North American and European LPs (30 per cent and 35 per cent respectively) and more than two-thirds (68 per cent) of Asia-Pacific investors intend to buy private equity interests in the next two years, the research suggested.

Jeremy Coller, CIO of Coller Capital, said: “Investor plans for secondaries sales show the scale of the change coming to the private equity landscape. Compare the situation today with three years ago. One-third of North American LPs plans to sell assets in the next 24 months. Whereas, in the summer of 2008, only one-fifth of investors had ever sold. When you also look at the proportion of investors looking to buy secondaries, the flood of money targeting new private equity markets and the accelerating pace of recruitment within LP institutions, it’s clear we are working in a rapidly-evolving industry.”

Sector Specific Funds & M&A Exits To Rise

In a significant pointer to the exit activity, about three quarters (73 per cent) of Asia-Pacific investors expect the large volume of cash on corporate balance sheets to result in a significant increase in PE exits to trade buyers within 18 months. Also, LPs expect sector-specialist PE funds to become more common. Seven out of 10 LPs (71 per cent) believe that sector-specialist funds will become more common in the private equity industry, the research suggests.

“This reflects a trend for growing specialisation by GPs across the world. For all GPs, being able to differentiate what they offer, compared with other managers, is increasingly important in order to attract investors,” said Mizuno.

LPs As Employers

The Barometer also has interesting perspectives on LP incentives. Between half and two-thirds of the investment staff at LP organisations has a performance-related element to their remuneration – and the majority of those do not (including three quarters of North American respondents) believe they should have one. The pace of change within LP organisations is also accelerating. Currently, three quarters (76 per cent) of LPs have been with their current employers for five years or more (and 42 per cent LPs for 10 years or more). However, investors believe a quarter of their peers will change employers in the next two years. This perception is supported by the plans of individual institutions – around one-third of all LPs plan to grow their private equity teams in the next two years – including almost half (47 per cent of public pension funds and 41 per cent of insurance companies.

Leave Your Comment(s)