Private equity funds ended last year with $1.074 trillion in liquid committed capital yet to be deployed. In 2013 private equity funds raised $431 billion globally, 13 percent more than the previous year, according to Preqin, an alternative-assets data firm in London. Private equity funds are poised to grow even more in size and across geographies during 2014. But the amount of capital sitting on the sidelines, a reduced deal flow and an institutional reexamination of all alternative assets have many worried.
“At this record level of dry powder and deflated deal market, investors are concerned that fund managers will still face challenges investing this growing capital base successfully going forward,” said Ignatius Fogarty, head of private equity products at Preqin.
Nonetheless, private equity funds continue to be the most attractive of the alternatives, says Jeremy Coller, CIO of Coller Capital, a London-based investor in private equity secondaries. Eighty-six percent of limited partnerships are forecasting annual net returns of 11 percent from their private equity portfolios. Some 25 percent of limited partners are anticipating net returns exceeding 16 percent. Private equity funds expect to distribute an estimated $120 billion to their investors for 2013 based on gains they realized on their private equity portfolios.
Many large pension funds are reexamining their investments in alternative assets. In October Yale University’s endowment, long a trendsetter in alternative investment policy, announced it would cut back its private equity investments to 31 percent from 34 percent. A November survey of 461 endowments by the National Association of College and University Business Officers and the Commonfund Institute found that college and university endowments have already started to cut back. Last month the California Employees Public Employees’ Retirement System announced it would eliminate as many as 269 of its 389 private equity fund managers. CalPERS has $31 billion of its $277.2 billion in assets invested in private equity funds and has committed an additional $10 billion.
One possible outcome of the cutbacks is greater scrutiny of private equity fund managers and a need for more transparency and greater disclosure. Many smaller private equity funds are already reporting difficulties in getting institutional investors’ attention or are being shut out entirely because they are too small. Many others are being asked to clearly define their exit strategies, especially if they will hold only minority stakes in their portfolio companies.
Large private equity firms seem unfazed by the marketplace and are targeting markets in Asia and Africa. In July New York–based KKR closed on its $6.1 billion Asian II Fund, the largest-ever pan-Asian private equity fund. Earlier last year RRJ Capital, based in Hong Kong, closed on a $3 billion fund. In November Mumbai-based Kedaara Capital announced it had closed on a $540 million private equity fund, with a large infusion from New York’s Clayton, Dubilier & Rice and the fund’s anchor investor, the Ontario Teachers’ Pension Plan, which has a dedicated private equity investment arm.
Africa will soon be the base for as many as five private equity funds, each with assets greater than $1 billion, says David Wilton, chief investment officer and manager for global private equity at the International Finance Corporation, the private sector development arm of the World Bank Group in Washington. Among the five are London-headquartered Helios Investment Partners and Dubai-based Abraaj Group, both of which already focus on Africa. Also in the mix are private equity giants Carlyle Group and KKR. Although the flow of capital is a reflection of optimism in the region’s growth potential, it may be too much money chasing too few deals, cautions IFC’s Wilton.
Indeed, several financial advisers say that large buyout funds are targeting Asia and Africa simply to buy time. “With opportunities to deploy large sums of capital in European and North American markets diminished, many are hoping that diverting capital to deals in Asia and Africa will placate investors’ calls for distribution,” says an adviser who wished to remain unnamed.
But Asian markets also are experiencing a distribution shortfall. Asian funds in 2012 paid investors back $38.7 billion, compared with $68.7 billion received, according to Preqin. Although 2013 figures aren’t available yet, industry experts don’t expect a vast improvement. Many investors are also worried that most fund managers, especially the smaller ones in significant Asian and African deals, do not have adequate capital to take majority positions in deals and hence have little control over their exits. “Only the large funds can afford to play in the new environment,” says a family office adviser who wished to remain anonymous.
This year large private equity funds are expected to build on the successes of 2013 and raise even more money. But the industry’s inability to return significant sums of money to its investors, especially at a time when equity markets provide both high returns and liquidity, suggests a tilt away from small and untested funds to the more established players.
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