2012 a vintage year but private equity faces challenge

Private equity investors see major challenges for the industry in the next few years, according to Coller Capital’s latest Global Private Equity Barometer.

Despite these worries, the investors (or Limited Partners) think 2012 will be a good vintage year and they expect strong medium-term returns from their private equity portfolios.

Fall-out from the bubble years is visible to private equity investors, says Coller Capital. Half of LPs believe they have ‘zombie’ funds in their portfolios – that is, situations in which private equity managers (General Partners) with no prospect of earning carried interest are motivated to keep funds going for their management fees. Neither are investors optimistic about their ability to remedy these ‘zombie’ fund situations: 72% of LPs think they will find solutions in only a minority of cases; a further 22% of LPs expect none of these situations to be susceptible of remedy.

The majority of investors also fear that, given today’s fragile credit markets, the re-financing of the ‘wall’ of buyout debt due to mature in 2013-15 represents a major risk to the industry.

Despite these worries, investors generally believe 2012 will be a good or excellent vintage year – over two thirds of North American LPs share this view – and their 3-5 year return expectations for private equity have almost returned to pre-crisis (Winter 2007-08) levels: one third of LPs expect returns of 16%+ from their private equity portfolios; half of LPs expect returns of 11-15%.

Jeremy Coller, CIO of Coller Capital, said: “Some people might be surprised that private equity investors are optimistic about returns when they see so many challenges facing the industry. I think the explanation lies in another of the Barometer’s findings: 93% of Limited Partners believe private equity investment results in healthier businesses. In investors’ eyes, the industry’s returns are underpinned by its ability to strengthen and add value to the companies in which it invests.”

One fifth of LPs around the world say they will reduce their private equity exposure to Europe because of the sovereign debt crisis. However, this does not imply a reduction in investors’ overall private equity exposure. On a global exposure basis, 17% of investors intend to reduce the share of their assets targeted at private equity, but this proportion is exceeded by the 24% of LPs planning an increased allocation.

Set against this, established GPs already hold large volumes of un-invested LP money: 87% of private equity investors have already received ‘investment period’ extension requests for some funds in their portfolios, and 78% of LPs expect to receive more such requests in the next 2-3 years.

Partly for these reasons, the fundraising environment will remain challenging. 93% of the world’s private equity investors expect to reject some ‘re-up’ requests from their GPs in the next 18 months – with a ‘typical’ investor refusing about a quarter of requests (though this proportion will vary considerably across the LP universe). Moreover, many investors will offer reduced commitments even to GPs with whom they do re-up: only one third of LPs say they will maintain commitment levels to all the GPs with whom they re-invest in the next 18 months.

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