Mumbai: It took consultancy firm KPMG India Pvt. Ltd nine months to come up with a report on how exits, both realized and unrealized, have worked out for $5 billion or 20% capital that has been invested in India by private equity (PE) firms from 1999 to 2011.

The report reiterates a few known facts about the Indian PE market such as the lack of exit routes and lower-than-expected returns besides a few not so well-known observations—the benchmark Sensex index on BSE has offered better returns than private investments, after taking into account costs associated with a fund structure.

Changing focus: Vikram Utamsingh says returns on PE investments will improve as investors are now focused on quality rather than the quantity of deals. Photo: Mint

The report indicates public markets have offered better returns than private investment. Is it safe to say that PIPE (private investments in public equities) deals are a better strategy?

PIPE deals are very different from investing in private companies. I think the only reason why we are seeing these kinds of results is largely because the industry was very young when it started investing and some of the exits that we are seeing today were made at the very early part of the industry. When the industry started in 2004, India was really going in one direction in terms of growing 7% to 8% to 9%.

There was a lot of investing that was taking place, perhaps without doing the right amount of due diligence, at times investors saying the valuation is okay when it was actually high.

Unfortunately, the industry has been hit by a global cycle, which turned negative in 2008, so all the investments that were made early in the day on the promise that portfolio companies will grow 20%-30% for five years and which would have given internal rate of returns of 25%, could not be met.

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Vikram Utamsingh speaks on investments in India by PE firms.

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What would be the short-term and long-term impact on PE investments due to the industry’s failure in offering desired returns and exits?

The short-term impact that we are already seeing is that fund raising is becoming increasingly difficult.

If you see, the private equity industry raised about $2.5 billion in 2010 and the numbers in 2011 are also very similar. What we are seeing is that folks who were attempting to raise money for the first time are not really able to differentiate themselves, and are, therefore, finding it very difficult to raise money.

The other short-term impact is that results are going to be bad for a couple of years because the industry is holding on to a portfolio of investments and we can assume that at least one-third of them will not make returns. So what are investors going to do with these investments? Ultimately, investors will have to exit them, write them off, or something. I think the industry will continue to see some bad news, for a couple of years.

In the longer term, we will see consolidation. I don’t see 300 funds operating in this country. I don’t think there are 300 funds operating even today because it’s about 70 to 80 funds that do at least one transaction a year, there are some funds that don’t do one transaction a year, and are referred to as private equity. What you will see is consolidation, what you will see is fewer players.

I am not too sure if the concept of corporates getting into PE will sustain. Because even the corporates will find that it’s really difficult and that this is a very unique industry which needs very unique skills to be able to make good returns.

In what light are LPs seeing India now?

Over the long term, the India story remains strong. I don’t think LPs are going to get out of India. What is changing is that instead of India being seen as an emerging market country within a group of countries, it has emerged as a separate asset class. So, LPs are looking for returns specifically from India. With this change, their return expectations have also gone up. They are now looking for net returns of 16%. Therefore, they are going to be extremely cautious with the funds they are going to back. They are going to back individuals and funds that have shown credible experience of investing in India and have shown credible exits. They are not going to back first-time funds.

Will Indian PE market continue to be vibrant?

Hopefully, the next 12 months are going to be a very good period for PE investments. To begin with, we have a stock market which is not very vibrant. So, there are a lot of IPOs that are not happening. These companies are now coming to PE firms to raise money. Those firms are also getting a bit tempered on their valuation expectations. There is a hope for the industry that 2012 will actually be a good year for PE investments. From the exit point of view, it will certainly be negative but from investment point of view it will hopefully be positive.

Will there be any change in India’s situation as a provider of returns?

I think returns will improve over a period of time simply because the quality of PE deals that investors are doing has improved. If you go back to investments in 2005-06-07, there was to some extent a herd mentality, people were thinking they were losing out at an investment opportunity because five firms were bidding for it. There was undue excitement on investments. I think PE firms have significantly matured now, they have undergone a negative business cycle and I guess reality has struck them.

They are not in a rush to make investments today. There is no pressure on funds to do two, three investments a year. I think the quality of investment has improved and, therefore, you shall see the results of quality of investment in 2014, 2015.

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