In a recent 2019 PE Outlook Report produced by Private Equity Wire, Andrew Bentley, Partner at Campbell Lutyens, a leading global placement agent in private markets, made the following comment when asked how he viewed the fundraising environment for 2019: “We expect most capital will be applied to servicing re-up requests from LP’s core existing managers, with new relationships being harder to consummate versus 2017 and 2018. Smart money will be looking for cycle-tested managers, proven cross-border reach and a technology edge.”
With the US/China trade war far from resolved, after the Trump administration decided on 9 May to impose a 25 per cent tariff on USD200 billion of China imports – swiftly followed by China imposing its own tariffs on USD60 billion of US imports – PE managers face the prospect of buying companies in more uncertain market conditions.
The risks of overpaying for companies, especially those exposed to global trade, are likely to be at the forefront of managers’ minds when seeking out where best to deploy dry powder. It is no surprise then that seasoned investors are likely to allocate to managers who have a track record of improving companies’ fortunes during the bad times, as well as the good.
“It’s hard to say given where the markets are today whether or not we might be teetering on the edge of a market correction and increased volatility,” comments Thomas Erichsen (pictured), Regional Director EMEA, Private Equity & Real Estate, TMF Group (London). “Any sophisticated investor is going to be interested in the track record of a manager when allocating to private equity, just as they are when investing in other asset classes. They want to understand how that manager has run their portfolio during difficult market periods and in that regard, emerging managers may not necessarily be viewed as a safe pair of hands.
“An investor might park some residual capital with a newer manager…but they’re not likely to back them with substantial capital, given the current market environment.”
The more forward-looking PE managers in the middle-market space are beginning to embrace the use of technology to help them improve their fund raising efforts and better connect with investors. Platforms like CEPRES, for example, are improving the whole portfolio monitoring and reporting aspect of investing in private markets. Its PE.Analyzer tool is the first benchmarking platform of its kind and as CEO, Dr. Daniel Schmidt, says: “Exchanging data with LPs builds confidence and it helps GPs by knowing exactly what their position is in the market.
Using technology to better understand the vicissitudes of LPs, and how they think about their PE allocations, can go a long way to improving the fundraising process because it gives managers a more focused, tailored approach. Still, Erichsen believes that compared to the hedge fund industry, PE managers are at least five or six years behind the curve when it comes to using technology.
“There’s a lot of catching up to do,” he remarks. “There is still a lot of manual intervention in PE firms, and also in PE/RE fund administration groups.
“We see our PE clients asking for more bespoke middle-office reporting services, which we can provide. The dynamics are changing thanks to technology advances. Managers want to be armed with more real data when they do their modelling and shadow accounting. As an administrator, we house all of this data. The question is, how do managers access it on a day-to-day basis without having to constantly call up their administrator to ask them to send a particular report?
“That relationship between PE managers and their administrator is likely going to continue to evolve.”
Technology is not just important for managers to improve their internal operations, it is also one of the most attractive market sectors to look for growth opportunities. In Europe, there are numerous ‘fintech’ or digital hubs in Luxembourg, Ireland, the UK and Germany that are home to a diverse range of early stage tech companies looking to make the next step in their evolution.
“A lot of companies in Europe are developing disruptive technology solutions to challenge the way a lot of things in traditional business are done. When analysing companies, PE managers want to see if they have the right supply chains in place, the right sort of market segmentation, and whether, by injecting a certain amount of capital, they might better streamline their operations with the use of technology to reach more customers.
“Another sector that we’ve seen clients exploring is the clean tech space; which one could categorise as a sub-sector of the technology space. A lot of people want to be first movers in this area and as a result a lot of capital is being deployed in that direction.
“PE groups with impact funds are also looking at Africa to invest in sustainability projects spanning agriculture, clean water production and so on,” says Erichsen.
One of the risks to investing in technology companies is having a high enough level of confidence that when it comes to exiting the investment after five years, for example, they are still relevant and well suited to serving the needs of its customers. This is no easy task given the rapid speed of technology innovation and the changing habits of consumers.
“What is going to be the next wave in terms of how people communicate and connect with each other? What is the next tech solution to emerge? Tech companies that launched a number of years ago are trying to redefine themselves to remain relevant. Is there business model sustainable for long-term use?
“These are questions that PE managers have to think about when investing in the broader technology space,” suggests Erichsen.
Another finding that came out of the Private Equity Wire 2019 Outlook report related to co-investing.
According to Andrea Auerbach, Head of the Global Private Investments Group, Cambridge Associates, approximately USD30 billion of co-invest opportunities were seen last year “but given that we don’t see all the deal flow, you could double that figure to USD60 billion”.
“Co-investing is a way to calibrate investors’ private investment exposure by investing in specific, individual opportunities. It allows investors to express their portfolio views in what can be a very distinctive way.
“Overall, I believe we could easily see USD100 billion-plus in co-investment deals this year,” suggested Auerbach.
Erichsen is not surprised by this forecast. In his view, “I think we are going to see a whole host of ways to attract capital into a fund and deploy it. You don’t see co-invest deals everywhere, however. They are typically only offered by investment managers who feel they are right for their strategy.”
Part of the reason for such solid investor interest in private equity, aside from the obvious return dynamics and decorrelation benefits to their traditional public security investments, is that it now offers much greater tactical investment potential. This is thanks to an ever deepening secondaries market, which has evolved in such a way that GPs, by and large, are less reticent to LPs wishing to relinquish their interests in a fund; be it for short-term liquidity needs or other factors. It is no longer the preserve of distressed sellers.
The PE secondary market has an estimated USD50 to USD60 billion of dry powder and as Erichsen says: “With so much dry powder out there, I think there will be situations where investors want to change their strategy and when you have a healthy primary fund market, there’s always likely to be spillover to create an equally healthy secondaries market.”
To underscore the fundraising power of those offering secondaries funds, the global behemoth Blackstone earlier this year raised at least USD6.9 billion for its 8th secondary fund, Blackstone Strategic Partners Secondaries VIII. The 2017 vintage raised an equally impressive USD7.5 billion in 2017.
Erichsen notes that part of the attraction for PE secondaries is that it gives investors an entry point further in to a fund portfolio’s investment cycle.
“Investors aren’t as close to the beginning of the J curve or too far towards the latter part of the J curve; investments haven’t evened out. There is still growth but the window of opportunity is shorter in terms of how long one’s capital is locked in.
“For some investors, that is a very attractive proposition. They can calculate what their returns are likely to be, over a shorter period of time. If you look at it from a risk perspective, it’s probably a lower risk/return profile.
“It’s an important way for investors to exit certain investments and redeploy their cash elsewhere. I think that is part of what’s driving the growth of the secondaries market,” concludes Erichsen.
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