Preqin’s latest outlook survey showed that limited partnerships intend to increase their private equity allocations. Out of 100 limited partnerships surveyed by Preqin, 59% indicated that they are looking to invest in small to mid-market buyout funds. Such partnerships also ranked private equity strategies in terms of opportunity outlook, and 46% saw small to mid-market buyout funds as the category offering the best opportunities. Large to mega buyout and secondary private equity offerings were tied on second place with 31% of limited partnerships indicating that they want more exposure in the next 12 months. Preqin notes that limited partnerships’ demand for secondary offerings is at its highest level since survey started. Increased deal flow is improving appetite for this strategy.

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Private equity demand and opportunities. Source: Preqin

Secondary offerings outperformed other private equity strategies

Preqin plotted net internal rate of return (IRR) against standard deviation of net IRR of private equity strategies. It included 10 vintage years (2001-2011). Secondary offerings had the best risk/return tradeoff. They generated an attractive median net IRR relative to the fluctuation risk taken. Buyout strategies and real estate exhibit the broadest ranges of net IRR and standard deviation. Some buyout strategies and distressed equities come second in terms of return per unit of risk.
Preqin notes that the secondary market has grown. There are more buyers and sellers. Transaction volume and fundraising seem to improve every year. Buyers find secondary private equity attractive because they can buy a fund interest at a discount relative to its net asset value, improve return in early years of private equity commitments and access top managers that may not have any new funds open. Sellers benefit from improved liquidity and use proceeds to rebalance portfolio or liquidate poor performing managers.

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Private equity strategies risk/return trade off. Source: Preqin

 

Early stage private equity least attractive

Early stage private equity exhibits the poorest risk/return tradeoff by having a median return of about 5% and a much higher standard deviation. The high standard deviation in this private equity strategy suggests that there may be some early stage managers that outperform significantly. High volatility can provide upside.
Venture capital also provides small returns for the volatility exposure. Recently, venture capital strategies have outperformed buyout and overall private equity market generating a return of 19.7% in one year ending December 2013. Venture capital investments’ prices rose and there were more exits. The latter helped investors lock in their returns.

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