Private equity: separating the wheat from the chaff
2011 will see the start of a widening performance gap between the industry’s winners and the rest, predicts Ernst & Young in its Global Private Equity Watch 2011.With banks and capital markets supporting a growing number of high-quality deals, conditions are improving for a sustained period of normalised investment levels. In an interview with LFF, Dr. Carmen von Nell-Breuning, Senior Manager Private Equity Business Development at Ernst & Young, Luxembourg, speaks about the industry’s outlook and Luxembourg’s role in private equity
Why is analysis of the performances of private equity funds so important for Luxembourg?
Over the past twenty years, Private Equity has established itself as an industry per se in Luxembourg and today represents an important area of business for the Grand Duchy. Non-regulated vehicles such as SOPARFIs (Société de participation financière) are widely used to structure international transactions and account for more than 25,000 vehicles. On the regulated side, the SICAR (a dedicated venture capital investment structure) and the SIF (specialised investment fund) have positioned themselves amongst the preferred European fund structures for institutional and qualified investors. Today there are over 245 SICARs and 1,230 SIFs domiciled in Luxembourg.
Developments in the global PE industry certainly had their effect on the level of PE activity in Luxembourg as regards both the structuring of PE transactions via SOPARFIs and the launch of new PE funds (SICAR and SIF). Nevertheless, Luxembourg has proven to be both highly efficient and stable in times of crisis. This stability and efficiency can be attributed to Luxembourg’s complete and flexible portfolio of tailor-made products and its unique business environment.
In the context of increased prudential supervision of financial activities worldwide and a changing legislative framework, Luxembourg positions itself once again as the pan-European hub for alternative investments funds and has been identified as one of the primary jurisdictions for redomiciling (unregulated) off-shore funds.
Could you summarise what the PE industry looked like in 2010 and the outlook for 2011 and beyond?
After a two year hiatus, 2010 saw an upturn in PE activity with increased deal values and a clear return of larger deals, as debt financing became more readily available. PE exits increased markedly and IPOs started to re-emerge as an exit route. Fundraising, however, remained challenging. Upcoming regulatory changes were further defined during 2010 and PE houses started to prepare themselves to manage future regulatory requirements.
2011 looks set to build on last year’s recovery despite continued volatility in the global macroeconomic environment. The PE industry has matured and 2011 might be the start of a greater separation between the industry’s winners and the rest of the pack. PE houses will face new challenges and need to define a concise strategy as regards the shape and size of their firms.
Geographic diversification with growing exposure to emerging markets will further increase. Value creation at the portfolio level will remain the decisive success factor. And finally, the ability to respond actively to, and manage, a growing stakeholder group will be increasingly the focus of PE houses. Firms need to strengthen their business processes to ensure that they have the right information at the right time to satisfy the needs of LPs, regulators and other interested parties.
The Global Private Equity Watch says that the relationship between PE and its stakeholders is becoming more complex. What are the reasons for this trend?
The PE industry has matured and PE firms are poised to extend their reach and influence, becoming increasingly important players in the capital markets and the global economy. As this reach extends, the relationship between PE and its stakeholders is becoming more complex: increased regulation, greater informational demands from limited partners, calls for more standardised reporting and the need for sophisticated business processes are the main drivers behind this increased complexity and will place pressure on firms to react to and embrace change.
What are the challenges for PE firms?
One of the most serious risks to PE investing would certainly be another macro-shock. A further rise in oil prices, increasing inflation and a rise in interest rates would negatively affect PE investing. Furthermore, sovereign financial risks seem likely to remain high, particularly in Europe, and represent a challenge to economic stability.
Finally, increased regulation and the need for adaptation will certainly put pressure on PE firms. In that context, larger firms should be at a comparative advantage given their greater internal resources and the fact that they have already gone a long way towards institutionalising their business. Mid-market and smaller firms could find it harder to adapt.
Globalisation and winning in the emerging markets are the keys of the future. What are the opportunities in countries like Brazil, China or India?
PE firms look to the emerging markets as they provide favorable long-term growth rates and upward socioeconomic mobility. They enter these new markets by raising niche funds targeting specific countries, regions and markets. Limited partnerships?LPs see in the emerging markets many of the characteristics that attracted them to the PE asset class in the first place – chiefly, the opportunity to earn returns that are better than public markets.
For instance, fund-raising for Brazil-targeted fundsincreased nearly 170% in 2010 over 2009. Underscoring the high interest in that region, two South America targeted funds were amongst the top 10 largest buyout funds closed in 2010 - a remarkable development. China has seen growth of PE transactions at an annualized rate of 53% over the last decade and continues to attract PE firms in search of opportunities that are largely unavailable in more developed economies. (See the recently published Ernst & Young survey: ‘Private Equity in China’.)
What are the strategies for investing in emerging markets?
Global PE firms have found two strategies are particularly successful in emerging markets: partnering with or acquiring stakes in established regional players to gain access and local insight, and/or raising funds in the local currency allowing for better access to local investors and avoiding foreign exchange controls.
Interview by Christian Welter.