Impact Of Brexit On Private Equity by Preqin
Fund Manager Outlook
Jeanne Kroeger examines the results from Preqin’s June 2016 survey of 187 private equity fund managers to find out their views on the latest industry developments and the challenges they are facing.
Challenges in the Industry
Valuations have been a growing concern among fund managers in recent years: of those surveyed by Preqin in June 2016, nearly half (48%) cited deal pricing as the biggest challenge facing the private equity asset class in the next 12 months (Fig. 1). Macroeconomic conditions are a concern for 38% of respondents, with events such as the UK’s recent decision to leave the EU and China’s economic slowdown creating volatility and uncertainty in global markets. Other notable concerns for fund managers involve fundraising (33%), complying with and adapting to regulatory regimes (28%) and the exit environment (27%).
The pricing of portfolio companies is the greatest concern for fund managers based in the traditional private equity markets: 55% and 58% of North America and Europe-based fund managers respectively cited valuations as the biggest challenge, compared with 24% of managers based elsewhere. Meanwhile, fundraising was cited as the key challenge for the industry by Asia-based fund managers (72%) and those based in regions elsewhere (55%). Unsurprisingly, due to the macroeconomic issues stated above, respondents based outside North America cited ongoing volatility and uncertainty as their second most pressing concern, which was reported by 41% of Europe-based fund managers, 50% of Asia-based managers and 48% of all other managers. Contrastingly, these issues were only a concern for 27% of North America-based respondents.
With valuations and pricing of portfolio companies cited as the key issue facing the asset class, it is unsurprising that 46% of fund managers have seen pricing for portfolio companies increase in the past 12 months, compared with only 17% having experienced a reduction in pricing (Fig. 2). Some fund managers are clearly concerned about the effect that increased pricing will have on the returns of their vehicles: 38% of respondents found that current valuations have led them to alter the targeted returns of funds that they are bringing to market: 29% have reduced targeted returns, while 9% increased them. However, 42% of respondents reported that their targeted returns are independent of pricing in the market.
A Competitive Landscape
Competition within the industry shows no sign of easing: nearly half (49%) of respondents have seen higher levels of competition for deals compared with 12 months ago, while only 7% have seen less competition (Fig. 3). The majority (53%) of fund managers have seen competition increase for mid-market buyouts, which could be due to the large number of firms operating in this segment. A fifth of respondents have had to alter their investment strategies as a consequence of the increased level of competition; one North America-based buyout fund manager stated that they have had to “increase the breadth of opportunities being considered”, while another Asia-based fund manager said that they are allocating “more capital to later stage investments, which are much cheaper than before”.
Thirty-eight percent of fund managers believe it is currently harder to find attractive investment opportunities than 12 months ago, compared with 8% that have found it easier (Fig. 4). This is particularly apparent among the largest fund managers surveyed (those with assets under management [AUM] of $5bn or more): no firms of this size have found it easier to find opportunities in the past year. Consequently, fund managers are having to work harder to source and identify viable investments, with over a fifth (42%) of all respondents having to review more opportunities for every investment they make, compared with 12 months ago.
The Importance of ESG Factors
Environmental, social and corporate governance (ESG) factors are of increasing importance to investors and fund managers alike; Government Pension Fund Global, one of the largest institutional investors in the world, excludes investments in industries such as tobacco, weapons and coal. As Fig. 5 demonstrates, the majority (53%) of respondents consider ESG policies for all deals and nearly a quarter (24%) take ESG factors into consideration for some deals. However, there are big differences regionally: nearly a third (31%) of North America-based fi rms do not consider ESG factors, compared with just 6% of Europe-based fi rms and only 2% of those in regions elsewhere. Furthermore, larger fund managers are more likely to consider ESG than the smallest: managers with $5bn or more in AUM take ESG factors into consideration for all deals, while only 45% of those with less than $250mn in AUM do the same.
Nearly half (48%) of fund managers surveyed have either occasionally or frequently decided not to invest in an asset due to ESG factors; however, 28% of respondents stated that ESG considerations are never a deciding factor when investing in a portfolio company (Fig. 6). Fifty-two percent of North America-based fund managers stated that ESG factors are never a consideration, significantly more than their European counterparts (18%) and managers based outside these two regions (13%). Furthermore, over a third (34%) of firms with less than $250mn in AUM state that ESG considerations are never a deciding factor, compared with just 14% of the largest firms.
The majority of fund managers have seen greater levels of investor appetite for private equity, which is unsurprising considering the high levels of distributions to investors from their private equity investments in recent times. In terms of investor types, fund managers have seen the greatest increase in appetite from family offi ces (58%), although notable proportions of respondents have also seen strong appetite from public pension funds (41%), private sector pension funds (38%) and sovereign wealth funds (38%, Fig. 7).
Regionally, 47% of fund managers have seen appetite from Asia-based investors increase over the past 12 months, the largest proportion seen in any single region (Fig. 8). In contrast, 45% of fund managers have seen more appetite from North America-based private equity investors, followed by Europe-based investors (40%), while only 21% of fund managers reported an increase in investor appetite outside these regions.
Despite the aggregate capital targeted by fund managers falling (for more details, see Preqin Quarterly Update: Private Equity, Q2 2016), the fundraising market remains highly competitive, with over 1,700 private equity vehicles currently in market. Over three-quarters (76%) of fund managers surveyed stated that the level of competition for investor capital had increased in the past 12 months, including 21% that cited significant increases (Fig. 9). Attracting investor capital across all regions looks set to remain challenging, particularly in countries outside North America and Europe, where 82% of respondents said competition had increased, including 39% that have seen significant increases in competition.