Private Equity’s Valuation Conundrum

Valuations are still a concern for GPs but managers expect to put more of their dry powder to work in 2016.

Private equity managers are concerned about high company valuations after struggling to deploy capital last year, according to Preqin.

Of surveyed private equity firms, 40% said they were most concerned about the prices quoted for portfolio companies. More than half (54%) of North American general partners (GPs) said this was their main concern.

Fundraising for private equity funds was strong through 2015, Preqin said, with a record $435 billion now in undeployed capital.

“With valuations cited as the largest challenge for the coming year, this suggests that private equity managers have been struggling to find the best investment opportunities at the right prices,” Preqin said in a report accompanying the survey.

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More than a third (38%) of managers said they felt it was more difficult to source attractive investment opportunities compared to 12 months ago.

“Rising valuations, and the impact they may have on returns, are clearly at the forefront of the minds of many fund managers going into 2016,” said Christopher Elvin, head of private equity products at Preqin. “Strong fundraising over recent years means that managers currently have a large amount of dry powder available to be deployed into private equity assets. With strong competition for assets, particularly in the developed markets of North America and Europe, valuations look set to continue to be a concern through the year ahead.”

Despite the valuation concerns, the majority of GPs surveyed by Preqin expected to deploy more capital this year than in 2015. Investor appetite for the asset class was expected to remain strong: 66% of managers predicted a “slight” or “significant” increase in the amount of competition for investor capital this year. Family offices in particular were eager to invest more in private equity, with 56% of managers reporting an increase in appetite from this sector.

Private equity appetite. Source: Preqin

Related:Valuations Fail to Deter Private Equity Investors

Carlyle Accused of Fraud by Ex-Employee

A former portfolio manager claims he was fired for blowing the whistle on “crazy” and “irresponsible” investments.

Carlyle Group has been sued by a former portfolio manager for one of its hedge funds, who accused the firm of “knowingly and intentionally fraudulent” behavior.

Nikhil Dhir, an ex-oil specialist for Carlyle’s Vermillion Asset Management, filed the case Tuesday. Dhir complained internally that the fund was misleading limited partners about an investment’s size, risk, and liquidity to avoid losing fees, the suit alleged, leading to his wrongful firing.

A spokesperson for Carlyle said the claims were “baseless and frivolous,” and that this is the second time Dhir has filed a complaint of this nature. The first, a case filed with the Department of Labor, was “dismissed with prejudice” last month, Carlyle said.

“Transparency, integrity, and our fiduciary duty are the core of our commitment to our investors and we will vigorously defend ourselves,” the spokesperson said.

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Dhir alleged Vermillion’s Viridian fund had built an overweight position in derivatives based on freight rates, with the portion of the fund allocated to freight growing to over 90% between 2012 and 2014. This is despite promises to investors—including public pensions—that no more than 30% of the fund would be allocated to a single commodity.

“In violation of how it was marketed to investors, this did not constitute a diversified investment fund, by any account,” the lawsuit stated.

The fund initially entered into the long freight position in 2012, and held on after Dhir’s dismissal in February 2015. According to the complaint, the partners of the fund consistently claimed that “the position was liquid and could be exited with minimal market impact.”

As the hedge fund suffered “large losses and a rapid increase in volatility,” Vermillion co-founders Chris Nygaard and Andrew Gilbert, along with Chief Operating Officer Chris Zuech, “told investors that the freight position was the right position, and advised them to keep their money in the fund for a recovery… because it would increase the amount of fees the partners would receive from investors.”

By October 2014, the case said, “every data point indicated the investment was risky and dangerous.” In a meeting with Gilbert and Nygaard, Dhir and other portfolio managers likened the situation to the Enron scandal. Nygaard responded that it would be better for the hedge fund to let freight go to zero, even though it would hurt clients, according to the complaint.

Dhir and others continued to raise concerns, accusing the fund of acting “crazy” and irresponsible.” Gilbert warned the portfolio managers would lose their jobs if they insisted that investors be advised of the problems, the suit alleged. Meanwhile, the fund’s partners continued to “mislead investors… about the nature of the risk and the continued viability of the investment.”

Dhir alleged he was “suddenly terminated” for his whistleblowing activities at the end of January 2015, despite having produced profits of $11.5 million in 2014. The other portfolio managers who complained were also fired.

Carlyle terminated Nygaard and Gilbert in June 2015 for “malfeasance,” according to the complaint. Zuech remains an employee at Carlyle.

Related: Carlyle Ends Collusion Suit with $115M Settlement

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