There will have to be a stronger, sharper and more sustained correction in global equity markets to put the brakes on further capital allocations in to private markets this year. That was the overall consensus on a fundraising panel at the recent International Private Equity Markets (IPEM) event in Cannes.
One could conceivably argue that the brakes have already been applied. Last year, the total amount raised fell 25 per cent from USD566 billion in 2017 to USD426 billion according to Preqin. But equally, one can’t expect record fund raising volumes year after year. 2018’s figure was still strong, and while investors are weary of the prospects of a global economic slowdown, if one looks at industry surveys there are no clear indications that they plan to rein in their PE investment programmes. Yet.
The challenge this year for managers will be how to
deploy all of their dry powder, in light of the market volatility we saw in Q4 2018.
“The DJ Industrial Average fell significantly last December but it is not yet enough for investors to implement a correction in their PE allocation,” commented Cristina Forcina Westermann, Managing Director, Houlihan Lokey. “For us, what is more important is distribution versus contribution. Distribution has exceeded contribution for the past eight years. We don’t expect that to change in 2019 and until that is the case, I don’t think a correction in PE allocations will take place.”
Marleen Dijkstra is a principal in the Funds Investment team at AlpInvest Partners, one of Europe’s leading PE groups with approximately EUR38 billion in AUM. She agreed that a big market correction would be needed for it to materially impact private equity markets.
“What we’ve learned having invested in private equity for more than 15 years is that a solid and consistent deployment is fundamental to achieving positive returns in the long run,” said Dijkstra. “In our experience, it is better to look at multi-year targets in PE rather than year by year to capture the market opportunities at each point in time. There is no need for any sort of radical response to short-term market volatility.”
Political uncertainty, led principally in Europe by Brexit, is not helping market confidence and is starting to influence fundraising activities among UK-based PE groups, with some moving ahead to set up new fund vehicles in Luxembourg. Others are sitting patiently on the sidelines to see if they can continue to manage their funds from the UK with equivalent EU passporting rights. Indeed, it is not yet clear whether UK managers will be allowed to manage Lux-domiciled funds and will depend on the final Brexit agreement.
“It is impacting fund raising in the UK,” suggested Cem Meric, Partner and Head of Private Equities Primaries Europe team, LGT Capital Partners. “We see some managers struggling more than others, especially those exposed to cyclical industries and sectors that might be affected by Brexit. Investors are extremely selective. Some have indicated that they will not invest in UK managers until there is more clarity on Brexit. The money is still there for high-performing managers though, with some managers successfully raising funds within a couple of months.”
Last year the larger players dominated, with several mega funds coming to market. In Europe, PAI Partners did a EUR5 billion raise, Triton Partners targeted EUR3billion for its fifth flagship fund, while Inflexion Private Equity Partners LLP, secured GBP1.25 billion for the Inflexion Buyout Fund V.
If the markets do become more volatile in 2019 and beyond, investors are increasingly going to allocate to GPs who can demonstrate consistent performance across market cycles.
“Given where the markets are now, investors are going to look for managers who have shown they can deliver good returns in the prior crisis,” suggested Dijkstra.
For managers who have shown they can do well in different economic conditions, it is natural for them to want to evolve and grow in size. However, investors want assurances that the experience garnered remains within the team as new funds are launched and also that the investment philosophy and process remains consistent if managers move into new areas of the market. Consistency of returns is really the key criterion, regardless of how a manager evolves.
Forcina Westermann said that because of the recent market volatility, global investors are trying to target strategies that are less correlated to the public markets.
“What I’ve seen in Europe, more than ever, is a shift among LPs towards PE groups with specialist knowledge in a certain niche,” she said. “In Europe, distressed strategies have been a little bit out of favour because of the abundance of cheap credit but now investors are saying this is the time for special situations and stressed/distressed strategies.
“Investors are looking for managers who can manage companies through a downturn not just through a bull market. Those who have done this in the past are going to be perceived by investors as a safer pair of hands.”
The panel noted that those GPs running funds in the Nordics and Benelux have produced good returns in the recent past and that the fundraising environment “will continue to be healthy” in those countries. In France, the spirit is much more positive than it was five years ago in terms of investment activity. The panel felt that the prospects for French GPs fundraising in 2019 should be good.
LGT’s Meric advised that GPs should stick to their terms and not to make too many changes when raising a successor fund. He felt that in the current market environment, LPs are less prescriptive about negotiating terms given the “fear of missing out” when it comes to securing an allocation. “Some GPs are pushing things more on the governance side – key man clauses and such like. But this is a long-term business so it is important to be fair and for GPs to take a long-term perspective,” said Meric.
Keeping fee terms consistent over time can lead to a smoother fundraising process and avoid potential irritation, on both sides.
As the panel agreed, good terms won’t turn a bad fund into a good fund and vice-versa.
Overall, they felt that despite the volatility and political uncertainty in Europe, the outlook for fundraising in 2019 was broadly positive.