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%).
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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.
Encouragingly, despite the ongoing concerns of many fund managers over pricing, a larger proportion (44%) of fund managers believe that exit activity will increase in the next 12 months than decline (23%, Fig. 10). Furthermore, fund managers appear optimistic about the growth of the asset class in the short term: nearly two-thirds of respondents expect AUM in the private equity industry to increase in the next 12 months (Fig. 11).
Awash with sizeable amounts of capital ready to deploy, most fund managers are confident that they can put capital to work despite the challenges within the asset class. The majority (62%) of respondents plan to deploy more capital in the next 12 months compared with the previous 12 months, with nearly a fifth (37%) looking to invest significantly more capital than before (Fig. 12).
Impact of Brexit on Private Equity
Using results from Preqin Special Report: Impact of Brexit on Alternative Assets, July 2016, Alastair Hannah examines fund manager and investor views to determine the potential impact of the UK referendum vote on private equity investment activity and portfolios.
Size of the Industry
Both the UK and EU* private equity industries have grown in recent years, although assets under management (AUM) in the UK industry is larger: UK private equity AUM stands at a record $272bn at the end of Q4 2015 (the most recent data available, Fig. 1). Private equity AUM in the rest of the EU stands at $206bn, although it has seen faster growth in the past five years, increasing by 36% since December 2010, compared with 11% for the UK industry in the same period.
In terms of the private equity deals environment, Preqin’s Private Equity Online features detailed information on almost 10,000 completed buyout deals in the UK and rest of the EU. Since 2007, there have been over double the number of transactions in the rest of the EU compared to the UK, for double the aggregate deal value (Fig. 2). However, the UK is the largest single market in terms of buyout deal fl ow in the EU: more than 3,000 buyout deals have completed in the UK – nearly twice the number of French buyouts – the UK’s closest competitor – and nearly three times the size of the German buyout market.
Furthermore, Preqin’s Private Equity Online shows the number of holdings from UK- and Rest of EU-based private equity firms. At the end of July 2016, UK-based fund managers held 1,749 UK portfolio companies, which is almost equivalent to the numbers held by Rest of EU-based managers (1,927). However, EU-based fund managers hold approximately three times the number of EU-based portfolio companies, with 6,567 holdings compared to 2,244 held by UK-based managers.
Fund Manager Views on Brexit
The referendum on the UK’s EU membership on 23 June 2016 saw a majority vote in favour of leaving the EU, resulting in volatility and uncertainty both politically and in the financial markets. In light of the result, Preqin surveyed more than 20 private equity fund managers to gauge the impact Brexit is likely to have on their portfolio performance and future UK and EU investment activity, in both the short and long term.
Key Findings: Performance of Portfolio
- No fund managers surveyed believe that there would be a positive effect on portfolio performance in the next 12 months, or over the longer term (Fig. 3).
- Nearly two-fifths (39%) of private equity fund managers were uncertain of the impact that Brexit will have on the performance of their portfolios in the next 12 months, while 28% believe there will be a negative impact and a third stated that there would be no impact.
- Over the longer term, the majority (53%) of fund managers surveyed are uncertain of the impact on performance, while a smaller proportion (16%) believe that the impact will be negative.
Key Findings: UK Investment Activity
- Just 11% of fund managers surveyed expect the Brexit decision to have no effect on their UK investments in the next 12 months.
- The majority (44%) of respondents expect to make fewer investments, while 11% anticipate making more. A third of fund managers were uncertain as to what impact Brexit will have on their investment activity in the short term. (Fig. 4).
- In the longer term, there is an even greater level of uncertainty, with half of private equity fund managers unsure of the impact that Brexit will have on the number of UK investments they will make. However, the proportion (30%) of fund managers looking to invest more in the UK is considerably larger, outweighing the proportion (20%) of respondents that are looking to make fewer investments.
Key Findings: EU Investment Activity
- Thirty-eight percent of private equity fund managers are uncertain as to how Brexit will impact their investments in the rest of the EU in the next 12 months, the same proportion as those which do not anticipate Brexit having any impact in the short term.
- Eight percent of fund managers expect to make fewer investments in the rest of the EU over the next 12 months, while 15% anticipate making more.
- Over the longer term, the largest proportion (43%) of fund managers believe that they will make the same number of investments, while 21% anticipate investing more. No respondents stated that they will make fewer investments in the rest of the EU.
Investor Views on Brexit
Preqin also surveyed 50 institutional private equity investors globally to discover the potential impact of the UK’s decision to exit the EU on their portfolios.
Key Findings: Institutional Private Equity Investors
- While the majority (51%) of institutional investors in private equity felt that Brexit would not have an impact on the performance of their portfolios in the next 12 months, more respondents felt that the impact would be negative rather than positive (40% vs. 9%, Fig. 5).
- The impact of Brexit on institutional investment in UK-focused private equity looks set to be significant: 43% of investors will invest less in the UK in the next 12 months as a result of Brexit, compared with just 9% that expect to invest more (Fig. 6).
- Over the longer term, a greater proportion investors (60%) anticipate no change to the number of private equity investments that they make in the UK.
- Investors surveyed by Preqin were less likely to make changes to their EU investments over both the short and longer term, although just 3% will invest more in EU-focused opportunities in the next 12 months.
The Evolution of Portfolio Monitoring Systems in Private Equity
– Jim Carr, Executive Director, Lionpoint Group
For well over a decade, the private equity (PE) industry has seen much volatility and transformation. Beginning in 2005 with the decrease in interest rates and loosening of lending standards introduced by the Sarbanes-Oxley Act, the industry saw an incredible boom in mega buyout deals. As capital was readily available and fundraising was at its highest, managers could afford to delay efforts on improving operational efficiencies and the supporting technologies.
Two years later, however, the industry experienced a discernible slowdown as the financial crisis spilled over and fundraising dried up. Although a total industry shakeout was averted (among the top quartile, at least) the financial crisis served as a catalyst for regulatory reform, an increase in due diligence processes and internal controls, and a shift in investor demand for accurate and timely data. As investor demands for transparency and tighter regulatory requirements took centre stage, PE firms looked to build more robust IT infrastructure and solutions to ensure accuracy and reliability in reporting.
Faced with the need for these “more robust” systems, functions that are historically performed in Excel spreadsheets (i.e. deal fl ow analytics, valuations, waterfall, partner carry calculations, performance analysis and financial reporting) have become ineffective and even unacceptable in an increasingly complex environment. In response to the need for more sophisticated operational environments and performance, firms have developed in-house tools or purchased off-theshelf systems to handle front-to-back operations in a more automated and integrated manner.
One area of great focus is portfolio monitoring, compliance and valuation. This has typically been addressed as subsequent to core portfolio management and accounting, however, is critical to performance monitoring of underlying portfolio companies or investments, as well as for meeting demands of greater transparency and regulatory requirements. Manual data collection, manipulation and analysis is being successfully replaced with automated processes supported by cloud-based portfolio monitoring systems.
These solutions offer greater transparency through streamlined data collection, validation and reporting, real-time dashboards, and the ability to slice and dice data on demand. Leveraging portfolio monitoring tools, fund managers, asset managers and investors are empowered by the ability to consume portfolio company operating data in a consistent fashion, identify errors or inconsistencies immediately, and focus their time and attention on data analysis rather than manual collection and manipulation. Gaining actionable insights through validated data in a central repository, managers have reliable data to measure historical performance and run sensitivity analysis. With the ability to upload and edit data directly from Excel, managers can quickly integrate the latest performance data into their analytics and models, enabling more time to analyze and sensitize the data.
The portfolio monitoring products offered in the marketplace have evolved tremendously over the past several years. There is a general consensus that portfolio monitoring and compliance is a separate function to portfolio management and accounting, requiring unique solutions to address the requirements. The products that have become successful focus on a handful of core capabilities including:
- An easy utility to consume operating partner data
- Flexible but manageable reporting and querying tools
- Easy integration capabilities to Excel
- Export and printing capabilities of dashboards and screens that are formatted and saveable to standard Microsoft products
- Functionality that is specifically focused to a defined client base (fund and asset managers as well as institutional investors)
The number of firms using these products will continue to grow in the coming years. We also anticipate continued consolidation of products in the marketplace via business combinations and acquisitions by larger players in the market including organizations that provide core General Ledger and financial functionality but lack portfolio monitoring capabilities.
Portfolio monitoring systems are now mainstream as opposed to “nice to have”. With the cost of these systems decreasing via more competition and scalable pricing, PE firms now have more opportunity to select and on board these solutions.
Private Equity Industry News
With our analysis of the healthcare deals market on pages 15 & 17, Jeanne Kroeger takes a look at the private equity healthcare sector, including recent transactions, fundraising and investors searching for healthcare funds.
Recent Healthcare Deals
So far this year, the number of private equity-backed buyout deals in the healthcare sector is on track to match 2015 levels, and current aggregate deal value ($25.2bn) has already overtaken the total seen at the end of Q3 2015 ($23.2bn). The largest transaction of 2016 so far is Helleman & Friedman’s acquisition of MultiPlan, Inc. in May for $7.5bn. As part of the transaction, GIC and Leonard Green & Partners will invest alongside Hellman & Friedman.
This was significantly larger than the second biggest deal of 2016 so far: Acadia Healthcare, a portfolio company of Wald Capital Partners, agreed to acquire The Priory Group from Advent International for approximately £1.3bn in January; Bank of America Merrill Lynch and Jefferies provided £925mn in debt financing for the deal.
There have also been 661 healthcare venture capital transactions for a total $10.4bn so far this year, the largest of which is the $500mn Series A funding of China-headquartered Ping An Good Doctor, a healthcare mobile app, from IDG Capital Partners and other unspecified investors, including global private equity funds, Chinese state-owned enterprises, financial institutions and internet companies.
Recently Closed Healthcare Funds
As shown in our Chart of the Month, there have been 43 primarily healthcare-focused private equity funds that have reached a final close in 2016 so far, securing $12.0bn in institutional investor capital commitments. Accounting for 28% of aggregate capital raised in 2016 is one fund, Welsh Carson Anderson & Stowe XII, which reached a final close in June on $3.3bn and will focus on buyout investments in the healthcare, business and information services sectors throughout the US.
The second largest primarily healthcare-focused fund to reach a final close in 2016 so far is also the largest venture capital fund: MF Venture Private Investments Infinity secured $950mn in April 2016 to make venture capital investments across all stages in healthcare companies based in North America and Europe.
Healthcare Funds in Market
There are currently 131 primarily healthcare-focused private equity funds in market, seeking an aggregate $20.9bn in institutional capital. The largest is Abraaj Global Healthcare Fund, which is targeting $1bn to provide growth capital to healthcare companies focused on healthcare services, retail pharmacies, distribution of medical technologies and medicine in the emerging markets of Africa, Asia and Latin America.
The largest Europe-focused fund in market is GHO Capital’s maiden vehicle GHO Capital Fund I, which is targeting €500mn to invest in mid-market buyout and growth healthcare investments in companies with a European presence and global potential. The fund held a first close on €500mn in June 2016. The largest venture capital fund in market primarily targeting healthcare investment is Domain Partners IX. The fund is seeking $500mn to target early stage companies exclusively in the life sciences sector.
Healthcare Buyout Deals
Anthony Leung explores healthcare buyout deals and exits over time, examining regional deal flow, industry foci and the largest healthcare buyout deals.
Healthcare Venture Capital Deals
Emily Forbes explores healthcare venture capital deals and exits over time, examining deal flow by region and stage as well as the largest healthcare venture capital deals.
Olivia Perry takes a look at investors that are interested in acquiring stakes in buyout vehicles on the private equity secondary market.
Emma Underwood provides the latest private equity performance data to Q4 2015, comparing the assets under management of different strategies and geographic regions, the returns of different investment strategies as well as the most consistent top performing private equity fund managers.
See full PDF below.