Pessimistic Sentiment Held Amongst Private Equity Investors

by Phillip Morton, Investors Offshore.com

16 June 2009

Wide-ranging changes to the private equity landscape will be seen over the next few years, according to Coller Capital’s latest Global Private Equity Barometer. Among the findings of the report, it found that private equity investors expect to see the disappearance of many existing private equity fund managers; defaults on commitments by about one in ten investors; a significant shift in the balance of power between investors and fund managers; threats due to regulatory and tax changes; and a further deterioration in investment conditions in the near term.

While some of this change might be viewed as an industry in renewal – a process of creative destruction – many investors are worried that regulatory and tax changes will inflict more far-reaching damage on the asset class. Half of private equity investors think this is likely to happen in Europe, and more than half expect the same to happen in North America.

The relationship between investors and managers will change strikingly over the next few years, notes the report. First, the players themselves will be different: investors expect a quarter of today’s managers (28% of venture capital firms and 23% of buyout firms) to be unable to raise a new fund over the next seven years – in other words, to go out of business. On the investors’ side, they think a tenth of all private equity investors will default on fund commitments in the next two years.

The balance of power between investors and managers is also changing fast, finds the report. Around four fifths of investors expect the terms and conditions of new buyout funds to become more favourable to them, and a majority – two thirds of investors – expect the same for new venture funds.

Investors also want improved transparency and risk management from fund managers. Over half of investors worldwide (and as many as three quarters of investors in Asia-Pacific) think a significant number of managers need to improve. One in ten investors think most managers need to improve.

Commenting on the Barometer’s findings, Jeremy Coller, CIO of Coller Capital, said: “Scarce capital, slower returns and political uncertainty are the immediate future for our industry. Living with these conditions will require all our celebrated spirit of partnership. Investors will need to be both patient and realistic, while managers will need to adapt quickly to investors’ changing requirements. Above all, investors and managers will need to stand together in the face of any ill-considered policy initiatives. It would be all too easy to break private equity’s alignment-based model by regulating away its flexibility or taxing away its incentives.”

Investors themselves expect to be harder pressed in days to come. Despite the fact that a third of investors are planning to reduce their number of manager relationships, over half of them (52%) expect resource constraints to reduce their ability to make and manage private equity investments. Different institutions are reacting to this in different ways. Those scaling back their private equity investment or retrenching organisationally (about one in ten investors) are planning to reduce the size of their private equity teams; however, a larger proportion of investors (almost a quarter) plan to take on additional staff to help them cope.

Economic conditions are likely to worsen in the near term, investors think. Three quarters of investors expect distributions from their portfolios to deteriorate further over the coming year. This will be the direct result of a stagnant exit environment: only a quarter of investors expect any short-term improvement in exits (though North American managers are somewhat more optimistic than their counterparts elsewhere).

Valuations, too, have further to fall – three quarters of investors believe valuations reported by managers at the end of 2009 will be significantly lower than last December’s audited valuations.

Other findings show that almost two thirds of investors are unhappy to see private equity fund managers making private investments in public equity (PIPEs). This view is shared by investors in all regions of the world.

On the other hand, investors in different parts of the world differ on managers buying the debt in their own portfolio companies. While 58% of European investors are happy in principle to see this happen, only 35% of North American investors think it appropriate. Investors in Asia-Pacific are evenly split on the issue.

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