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No end in sight to private equity market boom, says FERI

The market for private equity continues to ride a wave of success with brisk demand from investors, together with rising market valuations in respect of company takeovers securing another excellent year for the industry in 2017.

Although there are initial signs of some overheating in the large-caps segment, small caps continue to offer attractive investment opportunities.
These are the key findings of a current market assessment by the investment house FERI.
The proportion of alternative investments has increased significantly in recent years, as investors increasingly seek non-market-dependent sources of income and the broadest possible diversification for their portfolio.
“The extremely low level of interest rates that has characterised the market for a number of years has contributed significantly to the private equity boom. On the one hand, it has become easier to finance mergers and acquisitions using debt capital while, on the other hand, institutional investors desperately search for alternatives for investment,” explains Carsten Hermann, Managing Director Investment Management at FERI.
The result is that the market for private equity has grown rapidly in recent years. However, this success presents the industry with some new challenges. More and more investors are flooding into the asset class, and capital inflows are increasing, resulting in growing pressure to invest. Strong demand, coupled at the same time with a limited range of attractive investment opportunities, has pushed valuations to new record levels. Price multiples, usually defined as company value divided by EBITDA, have risen from 7.4 in 2012 to 10.0 by the third quarter of 2017 in Europe, meaning that purchasers had to pay an average of 35 per cent more for a company in 2017 than was the case in 2012. Prices in the United States have risen by 33 per cent over the same period.
There has been no interruption to capital inflows despite the high valuations. In 2017, private equity investors succeeded in raising USD 301 billion worth of private equity, spread across approximately 250 investment funds. This represents an increase of around 27 per cent on the previous year’s figure. The number of private equity funds launched in 2017 fell slightly compared to the previous year, while the number of mega funds rose significantly. This development reflects the tendency of large institutional investors to focus on a manageable number of manager relationships and on more substantial allocations per manager.
FERI analyses show that success in this year’s market environment depends substantially on managers’ ability to find attractive target companies at reasonable valuations.
“Investors should have a closer look at small and mid-caps, and at niche strategies. These are the areas in which investment funds can achieve attractive returns irrespective of the current market environment. Even over the next few years we expect target funds to provide positive returns of between 10 and 15 per cent in this segment,” says Carsten Hermann, adding that access to investment funds run by very good managers would continue to be difficult in the private equity segment over the medium term. “Investors such as FERI, who have been maintaining business relationships with these fund managers over the longer term, have a fundamental advantage over other investment fund investors in this regard.”

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