Poll: Amid Challenges, Private Equity Investors Are Cautious

Private equity investors foresee major challenges for the industry over the next few years and are cautious about investing too heavily in the asset class, according to Coller Capital's latest Global Private Equity Barometer.

(December 12, 2011) — The Eurozone’s sovereign debt crisis is burdening the ability of private equity firms to conduct deals, causing some investors to reject requests to reinvest in funds over the next 18 months, a survey conducted by private equity firm Coller Capital has found.

The findings portray the latest evidence that buyout firms face an increasingly difficult fundraising landscape. The study showed that one in five investors plan to lower their exposure to European private equity as a result of the continent’s debt crisis. An additional 69% said they would maintain their current levels of exposure to Europe. A total of 11% said they would increase their investments.

In signs that the fundraising environment will remain challenging, 93% of the world’s private equity investors expect to reject some ‘re-up’ requests from their general partners (GPs) in the next 18 months, Coller Capital’s survey showed.

The firm found that fundraising challenges are exacerbated by the pressure on limited partners to delay the commitments they do make.

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Despite the challenges, the survey found that 83% of investors plan to maintain or increase their target allocations to private equity over the next year, a sign that investors are focusing more on reducing the number of relationships with managers as opposed to simply lowering their allocation. Over two thirds of North American limited partners (LPs) share this view – and their 3-5 year return expectations for private equity have almost returned to pre-crisis levels. Meanwhile, one-third of LPs expect returns of 16% or more from their private equity portfolios; half of LPs expect returns of 11-15%.

Commenting on the findings, Jeremy Coller, CIO of Coller Capital, said: “Some people might be surprised that private equity investors are optimistic about returns when they see so many challenges facing the industry. I think the explanation lies in another of the Barometer’s findings: 93% of Limited Partners believe private equity investment results in healthier businesses. In investors’ eyes, the industry’s returns are underpinned by its ability to strengthen and add value to the companies in which it invests.”

Coller Capital polled 107 private equity fund investors, 40% of whom were located in North America, 40% in Europe and 20% in the Asia-Pacific region. In terms of assets under management, respondents ranged from under $500 million (16%) to $50 billion+ (18%). The majority of respondents (30%) were bank/asset managers, followed by public pension funds (13%) and endowments/foundations (13%).

In response to the study, Thomas Lynch of consulting firm and alternatives specialist Cliffwater told aiCIO: “Private equity needs a reasonable amount of economic and capital market certainty to work. Since Q1 2009, the private equity market has been growing more or less like a typical cycle with more deals and more distributions each quarter. However, the European Sovereign Crisis that began in June has caused a real pause in the cycle,” adding that buyout firms are reluctant to acquire firms when they can’t predict cash flows due to a potential economic slowdown. “The threat of a significant recession in Europe has caused large European buyout firms to halt transactions. To a lesser extent, the uncertainty has slowed deal activity in the US. Sellers are also less inclined to sell a company after a sudden drop in market valuations. The market cycle has clearly paused and we hope it does not turn into a significant retrenchment.”

On the plan sponsor side of the equation, Lynch noted, limited partners are especially sensitive to cash flows — with fewer distributions, they are reluctant to make new commitments.

Click here to watch an aiCIO video with Cliffwater’s Lynch speaking on the evolving relationship between institutional investors and large private equity firms as investors seek added expertise with more complex investments.

A new academic paper explores domestic sovereign wealth funds, with a focus on their origins, purpose, and governance, noting that such funds are wary of political maneuvering.

(December 12, 2011) — A recently published academic paper is asserting that political manipulation–often thought to be a tenant of foreign sovereign wealth funds–is also an issue on American shores.

The paper highlights that the rise of sovereign wealth funds in the US signals a shift in the balance of economic and financial power in the world, asserting that such funds are wary of political manipulation. While in recent years, a lot of attention has been given to the creation and use of sovereign wealth funds by fast-rising foreign powers, the paper by Paul Rose of Ohio State University’s Moritz College of Law asserts that many SWFs have existed for decades. Some of these older SWFs, therefore, are owned by US states, thus also implicating federal relations and domestic politics. “A great deal of research has focused on the international aspects of new, foreign sovereign wealth,” writes Rose, but “this article instead examines older (but much less studied) domestic sovereign wealth funds, with a focus on their origins, purpose, and governance, as well as the role they play within a federalist system of government.” The paper draws attention to the danger of political uses of sovereign wealth funds, when funds lean toward the discretion of politicians over fund managers, who aim to purely maximize returns.

“US sovereign wealth funds are often hesitant to be classified as SWFs because of political baggage,” Rose tells aiCIO. “The negative connotation comes from the perception among some that SWFs are often being used globally in a political way, by China, for example…Of course managers want free reign to be able to invest as they would any other aggregation of capital — they realize they have fiduciary duties and don’t want to be a political football for state legislatures,” he says, noting that some while some states, such as Alaska, have been successful at maintaining that insulation, other states, such as New Mexico, have had many problems.

“New Mexico has had problems with insulating their fund from political uses, which has contributed to a pay-to play scandal,” Rose says. In the report, he concludes that despite some of the concerns with state SWFs, these large pools of capital may, if properly designed, leverage political accountability through market accountability. “This is especially likely to be the case in Alaska, where an easily identified, market-related result—the annual dividend payment—encourages citizen attention to the government’s management of state resources. On the other hand, a poorly designed and poorly governed SWF is likely to increase problems with political accountability, as the SWF adds another means of rent-seeking by politicians and others,” Rose writes.

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The paper continues: “State SWFs also raise important concerns about state governance and state management of resource wealth. This article illuminates these issues by asking a few foundational questions: Why was the SWF created, and what role does it currently play? What are the financial, economic or equitable principles underlying its formation? Should a SWF be drawn down in times of economic distress? And how does the legal framework in which these funds operate ensure the funds achieve their stated goals?”

Click here to read an aiCIO Magazine cover story on the Alaska Permanent Fund and how the oil-rich state is leading the way toward a new method of asset allocation, bringing in some of the world’s most powerful money managers to do its bidding.