Valuations Fail to Deter Private Equity Investors

More than a fifth of institutional investors plan to allocate more than $1 billion of fresh capital to private equity in 2016, despite fears that the sector is reaching peak valuation.

A survey by Probitas Partners found that 21% of investors planned to commit more than $1 billion, while just 9% targeted an allocation less than $50 million.

No respondents planned to reduce their private equity target, while 17% said they are considering an increase.

This is despite nearly half of the respondents believing private equity to be at the top of its cycle—meaning a decline is looming. Of investors surveyed, 51% said too much money is pursuing too few attractive opportunities across the sector. More than a third said price multiples in middle-market ($500 million to $2.5 billion) and large-market ($2.5 billion to $5 billion) buyouts are too high, threatening future returns.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

Data firm Preqin has estimated that private equity firms worldwide held $1.32 trillion in unspent capital at the end of September 2015.

Another issue raised by Probitas’ survey was management fee levels, which 28% of investors said were destroying alignment of interest between fund managers and investors.

In spite of these concerns, 61% said they were considering expanding their current general partner relationships, while 27% said they were actively pursuing relationships with new managers. Just 6% said they were looking to decrease the number of relationships significantly.

Investors were most interested in US middle-market buyouts, a sector targeted by 76% of survey respondents. Other types of buyouts—including European buyouts and US buyouts of other sizes—were also popular, through interest dropped for buyouts larger than $5 billion.

Investors also favored growth capital funds in developed markets (preferred by 42%) and distressed debt funds (targeted by 31%).

Least popular were agriculture funds, timber funds, and green-focused funds.

Source: Probitas Partners’ “Private Equity Institutional Investor Trends for 2016 Survey“

The world’s biggest sovereign wealth fund has published proposals to overhaul its benchmarking process in preparation for entering infrastructure markets for the first time.

Norges Bank Investment Management (NBIM), which runs the $846 billion Norwegian Government Pension Fund—Global, has also formally recommended that the country’s finance ministry permit doubling the SWF’s real estate allocation and buy infrastructure assets.

“The index represents a strategy that the manager is expected to depart from if this helps improve the trade-off between expected risk and return.”“The benchmark model is not well-suited to the fund’s investments in unlisted assets,” NBIM wrote in its submission to the ministry. “NBIM’s proposed changes aim to address the challenges this presents, while also retaining the key features of the current division of responsibility between the ministry and NBIM.”

Currently, the fund’s equity and bond allocations are benchmarked to major indexes, but its direct investments in property do not have a formal performance comparator.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

Under the new proposals, NBIM would remove its fixed 5% allocation to unlisted assets. Instead, it would adopt a “holistic” approach, measuring risk and return for the whole portfolio relative to a benchmark of equity and bond indexes.

Citing similar approaches by top-tier pension and sovereign funds—including the Canada Pension Plan Investment Board, Singapore’s GIC, and the New Zealand Superannuation fund—NBIM said this would allow the performance of unlisted assets to be measured on excess return above a simple equity/bond split.

“The benchmark is no longer a strategy that the manager is expected to follow closely, but—through the size of the equity allocation—an indirect expression of the owner’s tolerance of variations in returns,” NBIM explained in its submission. “In this model, the index represents a strategy that the manager is expected to depart from if this helps improve the trade-off between expected risk and return in the portfolio.”

NBIM added that “only small adjustments” to its systems would be necessary to adopt the new approach.

In separate submissions to the Norwegian ministry of finance, NBIM recommended doubling its target allocation to real estate to 10%, with the ability to vary this by up to 5 percentage points above or below the target. It plans to reduce fixed-income investments to facilitate the move, should it be approved. Within this 10% target, NBIM proposed including infrastructure investments.

The formal request follows research published by NBIM last month, which made the investment case for a real estate allocation of up to 15% of its portfolio.