Private equity – Feature
around 5% of the portfolio in private equity. A year later, in May 2023, Nest confirms these estimates remain the same. As an update on progress, Jess Menelon, investment policy analyst at Nest, says: “We’re happy with the deals our fund managers HarbourVest and Schroders have found for us so far. “Deployment is going well with £460m, around 1.5% of our total portfolio, already invested as at mid-April, and we are con- tinuing to build our exposure to the asset class in line with our objectives.” For any institutional investor keen to introduce private equity to their allocation plans for the first time, there are significant considerations to be aware of, as one private assets analyst points out: “Private equity investing is typically characterised by negative returns as the funds incur management fees, trans- action costs and other expenses while waiting for the invested capital to generate returns.
“Institutional investors allocating money to private equity for the first time should diversify their investments with other pri- vate investments that are potentially quicker to gain value and to distribute money back, such as secondary investments and private-credit strategies.”
Under the surface
Despite the optimism about private equity, there are some sig- nificant lingering niggles in the market. State Street’s global research on private markets reported that investors remain somewhat jittery about the deal-making environment. More than half (51%) of respondents believe that private-equity valuations have not yet adjusted to new market conditions. Although private equity is not alone when it comes to accurate valuations – it is something rearing its head among many asset classes and sectors.
A potentially more worrying trend is that just under a third (32%) also expressed concerns about a private equity bubble risk due to falling revenues and profits of companies going to IPO. That said, this has been an issue hanging over private equity for some time. The question is, as investors fear, whether now is the time for the private equity bubble to burst. Reflecting on the current big issues for institutional investors around allocating to private equity, M&G’s Euers says: “Macro uncertainty, higher interest rates and reduced debt availability have resulted in lower deal volumes, and therefore lower liquidity, which further compounds overallocation issues.” He says several limited partners are slowing or stopping their commitments to new funds. And in some instances, they are being forced to sell private equity portfolios at discounts to generate liquidity and rebalance their portfolios. “The upshot is that many institutions are being highly selective when it comes to backing the current vintage of managers, many focusing on a smaller number of relationships,” Euers adds.
At the extreme, we should expect some franchises to ultimately fail.
John Euers, M&G Alternatives
This is having an impact in the market itself. “As such, we are seeing a bifurcation in the market where some managers are deemed to have successful fundraising campaigns (six to 12 months) at or above their target fund sizes whereas others are seeing a prolonged fundraising period, often needing to revise their fund targets to a lower level,” Euers says. “At the extreme, we should expect some franchises to ultimately fail,” he adds. “This is not necessarily a bad thing, more an evo- lution of an asset class that should no longer be deemed an ‘alternative’.” Vincent also highlights challenges that institutional investors are having to get to grips with. “Institutional investors are grappling with macro-economic uncertainty, ‘denominator effect’ issues, slowing distributions and reduced price discov- ery in private markets. “All these issues are contributing to a slower fundraising envi- ronment and a preference for established manager relationships.”
And LGIM’s Dietz fires a warning on the outlook for the rest of 2023: “We’re worried about economic conditions right now simply because rates have been hiked quickly in all the main markets − in the US, the UK and Europe − and we’re seeing the cracks showing up in the real economy. “Central banks might try to control inflation as a priority in this cycle and risk a little bit of a recession or some sort of an eco- nomic slowdown at least − and that is potentially negative for everything that is risky, including private equity.” If such a worst case scenario plays out, then private equity could switch from blowing the doors off, to finding itself part of a market implosion.
Issue 124 June 2023 | portfolio institutional | 49
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