After denominator, numerator effect is troubling PE funds

After denominator, numerator effect is troubling PE funds
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First Published: Tue, Mar 17 2009. 09 45 PM IST

Updated: Tue, Mar 17 2009. 09 45 PM IST
According to Preqin, a London-based research service that tracks private equity (PE) fund-raising globally, there are 78 PE funds on the road in 2009, looking to raise $24 billion (Rs1.23 trillion) in capital for India. Add to this the 117 pan-Asia PE funds, which also invest in India, and the number rises to $83.2 billion. But how much of this can be achieved? In 2008, though there were 84India-dedicated funds looking to raise money, only 16 were successful, raising a total of $4.56 billion.
With the same set of investors or limited partners (LPs) to draw capital from, namely pension funds, family offices and endowments from the US and Europe, and to a limited extent, sovereign wealth funds, the situation is unlikely to change.
More so since PE managers, who have had to grapple with their LPs facing a denominator effect, now also have to deal with a new phenomenon called the numerator effect.
The denominator effect meant reluctance on the part of LPs to allocate fresh capital to PE, as this asset class’ proportion in their total portfolio, on account of being not marked-to-market, looked unusually large towards the end of last year.
Take, for instance, an LP who had at the beginning of last year deployed $200 million, or 10% of his total $2 billion investable corpus in PE; the remainder being in stocks and bonds. The non-PE part of the portfolio, when marked-to-market, would have resulted in huge losses.
So, the $1.8 billion invested in stocks and bonds could now be, say $1 billion. The PE investments are normally not marked-to-market since they aren’t traded assets. As a result, the total allocation to PE stands increased to 16.67% ($200 million of $1,200 million). Approaching such an investor to raise incremental PE funds would obviously be unsuccessful, because the denominator effect has led to excess allocation.
Now, with many PE fund managers and their LPs realizing that they need to mark down private portfolios as well, to reflect market realities, the fear is that a numerator effect could also kick in.
Neeraj Baxi, principal at Ennis Knupp + Associates says, “Rather than carry them at cost, over the next two quarters, general partners (funds) will start marking down private portfolios to put a more realistic value on their investments.” Ennis Knupp + Associates is an institutional investment consulting firm with about 160 clients, largely made up of endowments, foundations and pension funds from the US.
Note that the adjustment of the numerator won’t negate the erstwhile denominator effect. Instead, experts feel that when investors see gaping holes in their private portfolios, in this case the numerator, there’s a chance that they may not be as open about incremental PE investments as they were before.
The markdowns will be especially severe for PE funds who did leveraged buyout deals. All told, the outlook for incremental PE investments continues to be bleak.
Write to us at marktomarket@livemint.com
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First Published: Tue, Mar 17 2009. 09 45 PM IST