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Rise in private equity allocations looks unstoppable, for now

Every investor class wants to boost their private equity allocation in the hunt for yield. But a crowded fundraising market in 2022 leaves the fastest returning managers with the upper hand, and others wondering how long the party can last.

Every investor class wants to boost their private equity allocation in the hunt for yield. But a crowded fundraising market in 2022 leaves the fastest returning managers with the upper hand, and others wondering how long the party can last.

The pandemic has been kind to private equity. With returns at near record levels and far overshadowing those from fixed income, institutional investors hunting for yield have also realised the relative stability on offer in comparison to more volatile public markets. 

Over USD 810bn was placed into private equity funds by investors in 2021 – the highest amount on record, according to data provider Preqin. 

With capital still flooding into the market, the amount raised in 2022 will be “unprecedented”, says Sarah Sandstrom, head of North American private equity at placement agent Campbell Lutyens. 

Though the start of the pandemic in 2020 forced some institutional investors to pause on new allocations to alternative investments, last year saw renewed optimism for private equity, an acceleration through virtual fundraising and a re-balancing of portfolios in favour of the asset class. 

Holdings of private assets are expected to rise 60 per cent between 2020 and 2025. Private equity is showing the most growth and will account for nearly 70 per cent of alternative AUM by 2025, says Preqin. 

Fast pace

In a survey of LPs published at the end of last year by Intralinks, it was found that the vast majority (around three quarters) would be increasing their overall allocation to alternatives (which includes private equity) over the coming 12 months. 

One-third of LPs surveyed expect this to be a three to five percent increase, while one in four plan to increase their exposure by 10 percent or more. 

“LPs are staying the course on their [private equity] pacing plans – increasing their allocations in some cases – a clear sign that investor interest in this asset class remains strong,” says Lindsay Creedon, partner at StepStone Group. “As the economy continues to show signs of recovery and growth, we foresee another robust year for fundraising in 2022.” 

Increasing allocations makes financial sense: institutions with a larger allocation to private markets typically experience higher returns, according to research published last year by Cambridge Associates. In the past decade, those with a private investment allocation of at least 30per cent have outperformed those with an allocation of 10 per cent or less by 200 basis points, it found. 

But as interest increases in private equity, some fund managers are looking at the flows and quietly asking ‘how long will it continue?’. 

“Whether or not that growth continues is still an open question,” says Peter Witte, associate director, private equity at EY. “But I don’t think that private equity firms are sitting there just waiting for that to happen. They’re actively out there looking for new sources of capital.” 

Speed limits 

Institutional investors such as pension funds and insurance companies typically maintain a relatively lower exposure to alternative investments in private markets as they are more closely regulated, giving them less flexibility to deploy capital. These institutions also typically have longer dated obligations that historically have been met with large investments in fixed income. 

Three things have changed in the past 18 months: more online pitching during successive lockdowns has accelerated fundraising cycles; pension funds have been setting more aggressive private equity allocations; and GPs have been creating more liquid fund structures to unlock new sources of capital. 

Among US pension funds, the portion of real-estate and hedge-fund investments has been falling for the past three years as private equity has been rising. Their private-equity investments swelled to an average 8.9 per cent of holdings in 2021 after three years of straight growth, says Preqin. 

At the end of last year, one of the world’s largest pension funds, the California Public Employees’ Retirement System (CalPERS), increased its allocation to private equity from 8 per cent to 13 per cent over the next four years, equating to around USD 25bn additional investment based on current AUM. 

The US administration’s Build Back Better plan is expected to generate a flurry of private infrastructure investment opportunities tempting even more institutions into the space. 

New policy guidance and legislation is nudging forward pension plans in other countries, from Switzerland to South Korea. 

Middle East-based institutional investors with deep pockets have also been moving into the asset class and pension funds in Germany and Italy are currently being targeted by UK-based private equity funds as the race for capital heats up, says fund managers. 

Though highly contested, efforts by private equity funds to tap such large institutions will continue. The landscape is relatively well mapped by fund managers and the largest pension funds (over USD 134bn AUM) currently allocate the least to private equity as a proportion of their total asset mix, according to data published last year by the OMFIF. 

One Canadian pension plan which has increased its private equity allocation from 7.5 per cent to 15 per cent since 2009 believes that a 25 per cent allocation could be achieved by some of the more mature pensions, through a mix of fund and direct investment. 

However, it is worth noting that some of these larger pension funds may currently be overweight to private equity due to outperformance over the past two years and therefore unable to deploy capital. Others – as in Canada, Australia and parts of Europe – may also directly in the asset class, without the use of fund managers. 

For these reasons, many GPs in Europe and the US are turning to other sources of capital where the hunt for capital is picking up pace: private wealth and retail investment 

Family affairs 

There are an estimated 7,300 single family offices worldwide responsible for around USD 5.9trn. Around eight out of 10 have some form of private equity investment, allocating around 16 per cent of their portfolios on average (split 9 per cent direct investment and 7 per cent funds), according to UBS data from 2020. 

Following a decade of booming private wealth their risk appetite is by far the greatest among all investor types and is growing still, say placement agents and fund managers globally. 

Almost a third of those surveyed by private client business Connection Capital last year said they plan to increase their exposure to alternative assets over the next 12 months, with the majority favouring private equity (66 per cent). Unsurprisingly, their main motivations were to diversify portfolios and achieve outsize returns. 

“Appetite for alternative assets among private investors has been growing steadily for some time, echoing what’s been happening among institutional investors,” Connection’s managing partner Claire Madden said of the findings. “Now is an opportune time to increase exposure to alternatives. Market conditions are creating some very attractive opportunities and post-downturn vintages are known to outperform.” 

But while it is true that more money is being allocated to private equity globally across almost all investor types, it is not being spread evenly across the fund managers out there and 2022 is set to be the most competitive fundraising market yet 

Read the rest of the Future flows: The next generation of private equity LPs Insight Report

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