Bangalore: Arecord number of investors are refusing to commit money to new funds being raised by private equity (PE) firms, citing a run of poor returns the past couple of years, says a new global survey.
Last year, 91% of European investors increased their so-called “re-up” refusals, compared with 63% in 2009, Coller Capital, a top investment firm in the international secondaries market, says in its latest bi-annual Global Private Equity Barometer.
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A re-up refusal is when investors, known as limited partners (LPs), refuse to re-invest in a particular fund or with one or more of their existing general partners (GPs), the fund managers. The secondaries market is where a firm buys stakes in investment funds or acquires portfolios of companies from the original investors.
In the Asia-Pacific region, such refusals from LPs increased to 70% from 52% earlier, shows the Coller report, based on surveys of 120 investors in North America, Europe and Asia-Pacific.
“This would not have any impact on PE activity in India. The only concern, when it comes to the country, is of returns,” said Hiro Mizuno, partner, Coller Capital, over the phone from Japan.
“There is a mixed feeling on performance of Indian GPs... While funding for Indian market is not an issue, the GPs need to prove sustainable, better-than-public-market returns,” he said.
Citing high costs and disappointing returns, LPs also want to reduce their exposure to funds of funds—or funds that invest in the portfolios of other investment funds.
Jeremy Coller, chief investment officer, Coller Capital, said this illustrates two industry dynamics: the continuing growth in investor skills and confidence, enabling more LPs to commit directly to GPs they like; and the more demanding nature of PE investors as a group. “There will certainly continue to be investor demand for funds of funds in the PE industry, but firms that cannot demonstrate a good track record and strong value-add will increasingly fall by the wayside,” said Coller, in a statement accompanying the report.
But LPs have particularly high expectations of deals by their GPs in 2010 and 2011, with 60% of them expecting these investments to achieve returns of 16% or more.
Half the LPs working for corporate and public pension funds, which are among the main investors in PE funds, believe their institutions are not maximizing returns from the asset class.
“India, by definition, is an emerging market for global PE firms. The GPs need to outperform or what is the point of taking an emerging market risk? If the investors expect 16% returns in developed markets, they expect 20% returns from India,” said Mizuno.
Indian GPs have to show that investments in the country’s private markets can do better than in the public markets, he added. “There is a very low valuation arbitrage between private and public markets in India. Private companies are often traded at the same multiple as public markets in India, which is something very unique to India,” he said.
LPs also expect venture capital (VC) investing to continue to be challenging, says the Coller report.
One-fifth of the LPs surveyed believe not a single VC firm can generate consistently strong returns over the next decade. Two-thirds of them say such returns can only be achieved by a small number of venture GPs worldwide. And at least one-third of the LPs in Europe and Asia-Pacific believe the climate for VC investing is getting worse.
“There is a shortage of capital to support early stage ventures. This, in part, is also due to the fact that more and more companies need early stage funding. Also, there are not many established VC funds in India. In emerging markets, there is always a shortage of capital for new businesses,” said Mizuno.
Also, 76% of the LPs expect another significant downturn in the PE market within seven years; 42% of them expect one within five years.
There is a big academic divide on the issue of whether the PE asset class is cyclical or not, said Mizuno.
“What became a bit clear over the last crisis is that PE is indeed a cyclical asset class,” he said. “The next two-three years will see a good recovery trend. For the next three-five years, the upward trend would continue and then go down as a natural cycle.”