There is a worrying high mismatch between private equity managers and their clients across a range of matters from returns, to fees, to communications, as a year approaches when mid-market private equity firms are expected to seek over €50bn from European investors.
Additionally 91% of investors feel managers should invest more in their own funds. On this point, at least, most managers (85%) agree.
bfinance’s study of 41, mainly European, investors in private equity funds looked more at return expectations, finding similar gaps.
Most investors (88%) named an improvement of their overall portfolio returns as the first or second most important reason for investing in private equity. But fewer than half of them actually achieved from their investment the most common return expectation, of net internal rates of return (IRR) over three years. Some 93% of institutional investors wanted this level of return.
Emmanuel Léchère, head of market intelligence group at bfinance, said: “Institutional investors have adjusted their expected returns downward across most investments strategies facing a significant amount of capital uninvested, high competition for transactions and extended holding periods driven by lack of financing and liquidity constraints.”
Lorenzo Rossi (pictured), bfinance’s managing director for private markets, said: “Average returns in the asset class often do not justify the illiquidity. Too often realized returns net of all fees fall short of expectations. Therefore, investors need to focus on selecting the right managers that can create superior absolute returns.
“Amongst these, investors should seek out those that are correctly aligned to extract value for investors, rather than for themselves.”
One notable exception to the trend of investor disappointment was private debt strategies. There, historic returns meet most closely with expectations. Here, 74% of investors expected a net IRR of over 10%, achieved by nearly 70%.
This strategy also gives a better risk-adjusted return than other private equity strategies, the consultants said.
The investors were more disappointed, on the other hand, if they invested in venture capital, where 87% of allocators expected over 10% returns, but only 44% got it.
And they were most disappointed if they invested in special situations investments, where 97% of allocators wanted the same returns, but only 24% got them.
Among other sub-strategies of the private equity family, there was a narrower gap in buyout investment strategies between those (89%) expecting over 10% IRR, and those (73%) actually receiving it.
Investors seem absolutely unwilling to suffer losses from their private equity investments, as 56% consider private equity an absolute return asset class. By comparison, only 7% of investors compare private equity returns to ‘inflation-plus’ indices, and only 51% compare to public market performance, plus a premium for illiquidity.