– Expecting PE Returns to Fall
– “World’s Wealthy Saved by PE”
– Search Funds Rise From the Shadows
– Long-Dated PE Funds Face Significant Challenges
– Secondaries Fundraising Boom Continues
– PE KeyTrends Quick Question Results
PARTNERS GROUP ADDS TO THE CHORUS: PE RETURNS TO FALL. In its H2 2016 Private Markets Navigator report the firm says that the “new normal” for private equity will be annual returns in the mid-teens. That’s low compared to “former times,” when PE gains “sat in the high teens.” What explains the lower return expectations of a growing number of PE investors are stubbornly high purchase prices – thanks to increased competition – and lower levels of leverage. In its coverage of the report, Private Equity International observes that PE buyers paid a near record 10 times cash flow in the U.S. and Europe in 2016’s first half. More equity relative to debt is also being invested compared to pre-financial crisis. Equity contributions were about 50 percent in Europe and 45 percent in the U.S. in the first half, versus a third of deal value pre-financial crisis. At blame: U.S. banking regulations, and in Europe, subpar loan performance and poor economic growth.
“WORLD’S WEALTHY SAVED BY PRIVATE EQUITY” IN 2015, declares Reuters. Citing the UBS/Campden Wealth Global Family Office Report 2016, Reuters notes that “the average family office portfolio returned just 0.3 percent in 2015.” The report’s authors, who surveyed 242 family offices, with average assets under management of $759 million, write that PE and real estate “outperformed most other asset classes, and will have saved many family office executives the indignity of delivering overall portfolio losses.” Though PE returned a relatively strong 5.9 percent and real estate an even better 9.2 percent, average returns from all asset classes came in under investor expectations for the third year in a row. This year PE’s share of the value of family office investment portfolios rose to 22.1 percent, up 2.3 percent from last year.
SEARCH FUNDS ARE RISING FROM THE SHADOWS, reports the Economist. They make up “such a small niche” of the private equity industry “that few in the business have heard of [them],” but that’s changing as investors seek better performance. According to Stanford University more than 40 search funds launched in 2015, “twice as many as in 2009,” and in six years acquisitions by search funds have tripled to over 15 annually. Typically, search fund managers are hungry “MBA graduates” who “raise $400,000 or so of ‘walking around money,’” and then go searching for a high-growth, high margin firm that they can purchase and run full time. With target identified – search funds tend to look for firms with $5 million to $20 million in revenues – they seek a final round of equity and debt funding. Although “about a quarter of searches come to nothing,” and a third end in failure, return on investment is about 8.4 times original equity, which may just make backing these young, motivated managers worthwhile
LONG-DATED PE FUNDS FACE SIGNIFICANT CHALLENGES, despite a “surge” in interest in such vehicles, according to the Economist. Blackstone, Carlyle and CVC are among a growing number of firms with private equity vehicles that “lock up investor funds for 20 years” and aim “to hold individual companies for at least ten.” They target net annual returns of 10 percent to 12 percent, not the typical 20 percent targeted by ten-year funds, but “promise less volatility and lower fees” – about 1 percent versus the standard 2 percent. Though they seem suited for sovereign wealth funds, endowments and other investors without defined short or medium-term liabilities, the Economist argues the funds should be approached cautiously. Low fees “may lure investors” but “give PE firms insufficient incentives to manage…diligently,” while the eventual sale-bonus for management may be so far off in the future as to not be competitive. Large investors “who would be the best fit” for long-dated funds may also be able to build internal PE teams cheaper. The Economist’s prediction: the recent surge is likely to sputter out.
THE SECONDARIES FUNDRAISING BOOM CONTINUES. That’s certainly the message of a WSJ Pro Private Equity story on the recent closing of Blackstone’s Strategic Partners Fund VII, a specialist secondaries vehicle that closed at its hardcap of $6.55 billion. The last Strategic Partners fund raised $4.4 billion in 2014. As WSJ Pro Private Equity notes, 2016 is “on track” for record secondary fundraising. “Secondary funds in the U.S. and Europe gathered $15.84 billion during the first half of 2016,” on pace to beat the 2012 record of $27.6 billion. The large amount of capital implies that secondaries volume, down some 17 percent year-on-year, according to industry estimates, may rise sharply in the second half of the year.