Mumbai: With investors due to exit from nearly 800 deals worth about $15 billion, the next two years could mark a crucial phase for India’s decade-old private equity (PE) industry.

At a time when inflation, high interest rates, volatile stock markets, falling rupee and governance issues have dented expectations from Indian investments, experts say the returns they yield will play a vital role in deciding future fund allocations.

“There is a lot of scepticism about India," said David G. Pierce, chief executive, Squadron Capital Advisors Pvt. Ltd, which has invested in Indian funds, during a conference organized by AVCJ on 2 December. “There is a sense that India is not being proactive about encouraging foreign investment. We have large pension funds that tell us why put in money in India...put the entire money in China."

Investors in PE funds, known as limited partners (LPs), have already started to put money in smaller funds with a sector-agnostic approach, and are increasing their holding period in Indian investments.

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Mint’s Deepti Chaudhary says it has been a dry week for the private equity investors as no major deals were signed.

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“Most LPs should be prepared for a five-year period for one company and about eight to 10 years at the fund level," said Praneet Singh, managing director, Siguler Guff India Advisers Pvt. Ltd, another fund of funds, during a panel discussion at the conference.

A study of one-fifth of all exits in India since 1999 shows PE exits have yielded lower returns than the Sensex, the benchmark index of the Bombay Stock Exchange, after including manager fees and other costs associated with an investment fund.

At least one-third of investments will offer negative returns, said the KPMG India Pvt. Ltd report, published last week.

Although 2010 was a landmark year, with exits from 174 deals yielding a combined return of $4.55 billion, the momentum could not be maintained this year due to volatile capital markets and other macroeconomic challenges. Until September, a total of 93 exits yielded returns of $2.2 billion.

Experts are not sanguine about the next year either.

“I would be happy if 30 exits are done in the current market situation," said Vivek Gupta, partner, mergers and acquisitions practice, BMR Advisors.

Gupta said exits will depend heavily on the capital market. If investors can’t exit through initial public offerings (IPOs) fearing low valuations, they would prefer strategic sales, followed by secondary sales, or selling stake to another PE fund.

“China has given an IRR (internal rate of return) of 21.8% and an economy like Japan, which is in stagflation, has given a return of 19%, while India has given an IRR of 9.9% to investors," said Hiro Mizuno, partner at Coller Capital, an investor in PE secondary market.

LPs want Indian fund managers to raise smaller funds, preferably with a sector-agnostic approach, as deployment of money becomes a challenge with larger funds, putting fund managers under stress to do more deals. The size of individual deals also increases with the size of the funds, and opportunities for big-ticket deals are limited.

“Smaller funds will be better aligned with the LPs’ interests," said Singh of Siguler Guff India.