The performance of private equity and venture capital investments improved in the quarter ending 30 June 2009, but difficult economic conditions continued to challenge both asset classes, according to Cambridge Associates.
During the second quarter of 2009, the Cambridge Associates Private Equity Index earned its best return since the end of 2007. The quarter also marked the end of a string of three consecutive negative quarters for the Venture Capital Index.
Though bettered by a number of public market indices during the first half of 2009, the long-term performance of private equity and venture capital continued to outstrip public equity performance.
"While the difficult economy continued to challenge investors in all asset classes, including alternative assets, the rebound of the public markets helped returns for both the PE and VC indices. Between the two, the PE index benefited more because its underlying companies are more mature than those in the VC index, and typically more closely resemble – and, in some cases, are – public companies. Some funds in the VC index also benefited from a slight uptick in IPOs in Q2. Of course, a recovery and improved returns for PE and VC funds ultimately depend on a healthier economy and increased liquidity in the forms of IPOs and mergers and acquisitions," says Andrea Auerbach, managing director at Cambridge Associates.
The PE index earned 4.3 per cent in the quarter ending 30 June 2009. The index’s gains were largely the result of improved valuations for companies in several of the industries hit hardest by the recession, including retail, financial services, and energy.
"It’s worth noting that for the first time since the ‘mark-to-market’ valuation methodology was adopted by funds at the end of 2008, public market performance positively impacted valuations for companies in the PE index," says Auerbach.
Seven of the eight industry sectors that collectively represented 90 per cent of the PE index’s value earned positive results in the second quarter. Media, the lone exception, fell only about 0.3 per cent. The three largest industries by size – consumer, energy and healthcare – together represented more than half of the PE benchmark’s value. Each sector rose between 3.4 per cent and 4.4 per cent, with healthcare performing best.
Capital calls from PE managers increased during the second quarter, but there was little change in distributions to their investors. PE managers called roughly USD7.4bn in Q2, about USD1.1bn more than in Q1. New investments have required more equity than those made in recent years due largely to tight credit markets. The combination of the need to invest more equity into new deals and the shortage of near-term exit opportunities has contributed to the trend of capital calls outpacing distributions, according to Cambridge Associates.
Funds launched in 2000 distributed the most money to investors during the quarter – roughly 30 per cent of total distributions. Investors in the 2004-2008 vintage funds paid in the most capital, contributing more than 90 per cent of the capital called by PE fund managers.
The Cambridge Associates US Venture Capital Index rose modestly, 0.2 per cent, in the second quarter – its first gain since the second quarter of 2008. The 1999 vintage year venture capital funds were the best performing, returning 3.5 per cent, with earnings driven largely by increased valuations and realisations in IT and software. The 1999 vintage, along with five others – 2000, 2001, 2004, 2005 and 2006 – accounted for nearly 80 per cent of the VC index’s value.
Healthcare, IT and software continued to represent nearly 75 per cent of the index’s value. All three sectors earned positive returns for the second quarter, with healthcare faring best with a 3.0 per cent return, followed by software and IT. Virtually all of the 2006 vintage funds’ return was earned through healthcare investments. The 2001 vintage funds were the worst performers of the six vintages listed above, losing 1.5 per cent.
The benchmark’s VC fund managers called about USD2.7bn from investors in the second quarter, and returned roughly USD950m, both numbers closely mirroring the prior quarter. Several of the younger vintage years – 2004 through 2008, along with the 2000 funds – together called 92 per cent or USD2.5bn of the funds called during the quarter.
While valuations for VC-backed companies benefitted somewhat from the public market rally, the difficult economy and a poor IPO market continued to challenge venture funds.
"The recent shortage of profitable exit opportunities has caused managers of many of the more ‘mature’ funds, such as those raised in 2000, to hold companies longer, which reduces their internal rates of return," says Peter Mooradian, managing director at Cambridge Associates. "We believe, however, that the 2008 financial crisis could lead to a sustained and meaningful industry shakeout that should improve the competitive environment and entry valuations, other important components of the return equation."
According to the National Venture Capital Association, there were five initial public offerings and 64 mergers and acquisitions in the second quarter, many of which involved IT companies.
