If one looks at Private Equity & Real Estate (PERE) assets, they’ve been growing substantially over the past decade. Since December 2007, PERE assets have more than doubled from over EUR3 trillion to EUR6 trillion.
“Today we have around EUR6 trillion of committed capital invested and that is set to grow over the next few years to between EUR8 and EUR10 trillion. There are huge amounts of capital flowing into the private equity and real estate assets,” comments Ravi Nevile (pictured), Private Equity and Real Estate Portfolio Director at TMF Group.
Much of this doubling in size of PERE assets can be explained by investor behaviour. Since the ’08 global financial crisis, a persistent low interest rate environment and weak returns in other asset classes has led investors to diversify their investments.
“The growth is also not just in the buyout space but across the spectrum from buyout, growth, secondaries, credit and even venture capital funds, which are much harder to access. The same is true on the real estate side where we are seeing more diversification across retail and particularly logistics, which has been a stronger performing sub-asset class,” comments Nevile. What is clear is the diversity of asset classes across the PERE landscape has increased the complexity both in the front and back office.
This has led the largest institutional investors representing Pension Funds and Sovereign Funds in The US, Canada, Middle East, Asia and Australia to build out their own internal investment teams to improve their level of sophistication in order to invest directly in PERE assets as well as manage operations and third party fund and SPV administrators.
As investors become increasingly sophisticated and experienced, there is now a greater desire to invest directly or do co-investments with GPs or JV structures rather than into fund structures.
“They are looking to have greater ownership of their investments. With that comes a whole array of issues that need to be considered in terms of how you structure the investment, how you administer it, what gets done in-house by the investment manager and what gets outsourced.
“I would also say there are huge regional differences between the US and European market. The European market is highly regulated with all European managers being subject to AIFMD regulation and have a whole range of reporting and regulatory compliance requirements to adhere to and hence outsource many of their back-office functions.
“The US market is completely different. Most US GPs still do a lot of work in-house. There is still a huge piece of the US PE market that is yet to move towards an outsourced model; probably only 30 per cent of managers outsource but that is slowly changing and the same can be said of the real estate market,” argues Nevile.
In some respects, private equity has become a victim of its own success with approximately USD1 trillion in the form of dry powder (or capital yet to be invested). Factor in the increased level of competition and increasing valuations and one can appreciate just how hard it is becoming for GPs to effectively put that capital to work and deliver higher earnings multiples tomorrow.
The upshot of this is that some investors are looking to foster a smaller number of more meaningful GP relationships. The largest investors in the Middle East, Asia and Americas have a history of investing for decades into the asset class. As a result, says Nevile, if one looks at their balance sheet, there is a large number of managers they’ve invested with over the years and they are now looking to rationalise that and focus on those partners that can provide them with more co-invest and direct investment opportunities.
“This move towards consolidation is partly a consequence of co-investing. A large investor might allocate to a commingled fund but then decide to co-investing additional capital alongside the manager in a separate deal. However, this can affect the risk profile and, potentially, change the way the GP deals with that investor,” comments Nevile.
He agrees that with so much dry powder in the market, investors have to be confident that the GPs they allocate to are able to invest effectively.
“It is a concern for investors. Last year, CVC raised EUR15.5 billion in what was one of the largest European fund launches, while Apollo raised USD23.5 billion for the largest ever buyout fund. These are substantial numbers. In this environment, it might be easier to raise capital but it needs to be the right fit for their investment strategy and for their investment teams to allocate.
“As a GP, you want to raise the right level of assets for the fund in order to maximise returns for investors and through that alignment, you will get paid through carried interest.
“It will be interesting to see how some of the recent vintages end up performing in this investment cycle given the amount of competition and the extent to which valuations have risen in the market,” remarks Nevile.
Of course there are a myriad of excellent private companies particularly in the US. As always, it comes down to buying at the right time and price. That is where PE managers earn their stripes.
Gone are the old days where a PE buyout firm could come in, do some financial engineering, enhance the balance sheet and flip the company at a higher earnings multiple.
“Good PE managers are increasingly enhancing in-house operating partners with specialist knowledge of their sectors who can help advise management teams on how to improve efficiencies and the overall financial health of the company.”
“There is a lot more work being done, operationally, to extract value from companies and deliver returns to investors. It is a tough environment. Many GPs are looking to deploy capital in the US and Europe and are competing to find the best opportunities,” adds Nevile.
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