This content is from: Portfolio

Institutional Investors Warming Up to Private Equity

Investors have become more confident about the ability of private equity investments to generate strong returns.

It looks like institutions are slowly warming up to private equity again.

Nearly two thirds (64 percent) of 100 limited partners that alternative assets research firm Preqin recently spoke with said they had made new commitments sometime in the first half of this year. This compared with 54 percent that were interviewed for a similar study in June 2010 about commitments made in the first half of that year.

In addition, more than half of this group, or 57 percent, reported that they expect to make additional new commitments before the end of the year. A further 15 percent said they plan to make their next commitment sometime in 2012. London-based Preqin points out that 16 percent of the limited partners plan to make new commitments on an opportunistic basis. This means they could make their investment in a new fund before the end of the year if an attractive opportunity arises.

Investors have also put their money where their plans are. In the first half of this year, 311 funds closed, after raising a total of $141.8 billion. That works out to more than half of the $265.7 billion raised by funds that closed in all of 2010. “Investors are gradually regaining confidence in the asset class and, while many are not investing at the same pace as in the years prior to the downturn, fund managers should be encouraged that the number of investors looking to make commitments is steadily improving,” Preqin asserts in its report.

Keep in mind, however, that this survey was taken before this summer, when global market volatility intensified. The four straight monthly losses suffered by the Standard & Poor’s 500 index from May through August have spooked a lot of investors. No doubt they include those mulling whether to make the kind of long-term commitments demanded by private equity funds.

Investors certainly remember the losses — and lower-than-expected returns — generated by their commitments to private equity funds during the alternative assets bubble in the middle part of the previous decade. If high volatility and declining markets remain the norm for the next few months or year, private equity funds will be less likely to unload some of their earlier investments or take portfolio companies public. That means less money will be returned to limited partners, which in turn will have less new money to commit to funds.

Indeed, Preqin points out that the group of 100 reported that they plan to commit more to the asset class in 2011 because they have more capital available following distributions from existing funds in their portfolios. Obviously, that situation may change.

In any case, these investors have become more confident about the ability of private equity investments to generate strong returns. For example, Preqin reports that 90 percent of limited partners expect their private equity portfolios to generate returns that are more than 200 basis points above public market returns. More significant, 70 percent expect their private equity investments to achieve returns in excess of 400 basis points above the public market benchmark. This is up from 53 percent that expressed the same level of confidence in last year’s survey.

Interestingly, 68 percent said their private equity investments met expectations; this was down from 70 percent last year. On the other hand, 13 percent this year said the investments exceeded expectations, compared with just 9 percent last year, while slightly fewer limited partners expressed disappointment with the performance of their investments. “The proportion of LPs that feel dissatisfied with the overall returns from their private equity investments has steadily declined over the last two years, with less than a fifth of LPs interviewed in June 2011 saying that their investments in the asset class have fallen short of their expectations,” Preqin adds.

In what kinds of funds do these investors plan to put their money over the next 12 months? Nearly half (49 percent) singled out small to midmarket buyout funds, while 23 percent cited distressed funds and 22 percent said venture funds.

Of course, if the public markets continue to tumble and enter a bear market, or even if they continue to swing wildly up and down for a prolonged period of time, all bets will probably be off until the environment stabilizes.

Related Content