Mumbai: One in every five limited partners (LPs)—investors in private equity (PE) firms—across the globe says it will reduce its exposure to private equity in Europe because of the sovereign debt crisis even though this doesn’t imply a reduction in investors’ overall private equity exposure.
In terms of global exposure, roughly 25% of LPs are planning an increased allocation, compared with 17% of those that intend to reduce the share of their private equity assets, said a survey of 107 LPs by Coller Capital, a global investor in the secondary market for private equity.
The increased allocation by LPs may be good news for other emerging markets, but not for India. The Indian private equity industry failed to perform as well as other emerging parts of the region, said Hiro Mizuno, partner at Coller Capital, on the phone from London. “They even underperformed compared with Japan and other developed regions. From an investors’ perspective, if India is an emerging market, but hasn’t delivered as well as the Japanese PE market, what’s the point in taking the extra risk?” asked Mizuno.
India doesn’t have its own set of home-grown LPs and it is very difficult for investors to keep investing in a market where there are no domestic investors, Mizuno added. “You don’t really have Indian LPs, which is really tough because GPs (general partners) either have to live with a very small fund or have to depend on foreign investors.”
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GPs are the managing partners of the private equity fund. LPs in PE firms see major challenges for investments in the next few years as a majority of them have so-called “zombie” funds in their portfolio.
Zombie funds are those investments that have become inactive and are not expected to make a profit. Those who have invested in such funds are not sure whether they have the ability to salvage these investments, said the Coller Capital report.
Only one in five LPs expects to participate in the “first close” of the majority of funds to which it commits.
First close refers to the official establishment of a PE fund partnership when the first investor commitment is received.
Nearly half the 107 LPs surveyed by Coller Capital believe they have funds in their portfolio which have not performed very well and where the general partners (GPs) have little chance of getting carried interest or carry—a nearly 20% share in a fund’s profit that goes to fund managers at the end of a fund’s life cycle. The feeling is particularly prevalent among North American investors 57% of whom claim to have invested in “zombie” funds.
“Zombie fund GPs have no incentive to exit assets quickly and shut funds down because they will both be giving up on management fees and throwing away any remaining chance of getting ‘into carry’,” said Mizuno.
Fund-raising will be difficult with 93% of LPs refusing investments in a follow on fund in the next 18 months and reductions in commitments will be common, the report said. Also, these fund-raising challenges have become more significant with pressure on LPs to delay even the commitments they do make.
Twenty per cent LPs expect to participate in the “first close”, compared with 17% of 107 LPs surveyed say they will never make a first close.
“LPs are very cautious as their regulatory concerns are high. They want to spend more time than ever in due diligence. Unlike in 2006 or 2007, they are also less worried about funds being oversubscribed,” said Mizuno.
Meanwhile, 87% of private equity investors have already received “investment period” extension requests for some funds in their portfolios, and 78% of LPs expect to receive more such requests in the next two-three years.
Despite these worries, investors generally believe 2012 will be a good or excellent vintage year. One-third of LPs expect returns of more than 16% from their private equity portfolios and half of them expect 11-15% return. The biannual Global Private Equity Barometer report, released on Monday, says investors expect the best investment opportunities for GPs in the next couple of years to come from corporate disposals and sales by families/entrepreneurs.
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