While private equity funds remain flush with cash, a shortage of good investment opportunities and structural challenges are hampering the industry’s already sluggish recovery from the financial crisis, according to a study conducted by SEI.
Updating two previous surveys from 2009 and 2011, SEI’s latest study, ‘Key course adjustments for breaking through: Five ways private equity managers can optimize their competitive advantage,’ identified some positive industry trends.
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Allocations to private equity are on the upswing; 36% of investors surveyed this year said they are increasing their allocations to the asset class, versus 26% in the 2011 survey. Additionally, new sources of capital are surfacing, including institutional investors and sovereign wealth funds in emerging markets.
The survey also found that an increasingly active secondary market is helping managers to exit investments despite the slowing pace of initial public offerings. 61% of respondents said they use the secondary market in some way, compared to only 30% in 2009, and two-thirds said secondary buyouts will be ‘a key driver of deal flow’ in 2013.
At the same time, the study depicts a Darwinian climate of intensifying competition in which many funds will struggle to survive even as new ones come forward.
Jim Cass, managing director for SEI’s Investment Manager Services division, said: "Our survey reveals an industry where buy/sell dynamics are out of balance. Private equity funds have a glut of assets, but are starved for quality acquisitions and viable exit opportunities in certain strategies. Until that shifts, the industry appears caught between the proverbial rock and a hard place."
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By GlobalDataAmong the key challenges facing the industry, the report cites:
- A dearth of acquisition targets. Some 4,500 funds with an estimated total of US$1 trillion in uncommitted assets are chasing a limited supply of opportunities. In fact, those surveyed named ‘finding quality investment opportunities’ as the industry’s greatest challenge, far outstripping concerns with new regulations or tax increases.
- A ‘mountain of dry powder.’ The industry’s oversupply of assets is driving up valuations of potential acquisitions at a time when rising equity markets are having the same effect. More than 6 out of 10 survey respondents said the industry’s surplus of cash is resulting in more competitive bidding situations, and 45% said it is raising sellers’ price expectations. It is also making new fundraising more difficult, according to nearly half of the managers surveyed.
- Rising performance pressures. Investors and consultants are increasingly looking to private equity investments as a source of higher returns, over portfolio diversification. They also rank performance as the second most important factor in fund selection. But many funds are being hobbled by unprofitable investments and the stiff competition for acquisitions. The report finds having invested at the peak, or been unable to invest all of the capital raised, some firms will simply be unable to produce positive returns for their limited partners.
The report suggests five steps private equity fund managers can take to become more competitive:
- Utilize untapped sources of capital.
- Adopt more flexible fee structures.
- Capitalize on the secondary market for exits.
- Leverage technology and operational partnerships.
- Implement standardized filing processes.
The SEI study included a global survey of 654 institutional investors, fund managers, and consultants in the private equity arena. The study was conducted by the SEI Knowledge Partnership, which provides ongoing business and marketplace intelligence to SEI’s investment manager clients.
