Private Equity Offers Safe Harbor in Volatile Markets

Current Market Volatility Felt by PE: The volatility that we are witnessing in the equity and debt markets is already manifesting itself in private equity fundraising, but not in the way that many GPs would expect. Obviously, some LPs with overweighting to energy or high yield debt have been sidelined by the downturn in those sectors, but other LPs have been underwhelmed by public equity and hedge fund performance recently and are seeking superior returns from alternatives. During the Global Financial Crisis we experienced such sharp declines in the public equity markets that many LPs experienced a “denominator effect” which required a rebalancing of their portfolios at the expense of their private equity investment programs. The volatility that we are seeing today is not nearly as dramatic and private equity has often become the beneficiary of LPs seeking to mitigate the short-term performance variability and capture incremental performance not offered by the fully valued public markets. So, instead of a complete rebalancing, there is a more subtle shifting of focus and capital toward fund managers and strategies that fare better in these more volatile economic conditions.

Effect on Exits and Fundraising Timing: Many fund managers, anticipating a downturn, have decided to return to the fundraising market earlier than anticipated in order to access what they perceive as a reduced allocation before markets cool. As discussed, the good news is that we are not yet seeing a reduction in private equity fundraising volume and in some instances we’ve actually seen an increase as underperforming asset classes are pared back. That being said, it hasn’t been all champagne and caviar for GPs during this recent downturn. Fund managers are finding it increasingly difficult to exit portfolio companies at the pace and valuations that we were all accustomed to seeing in 2015. This is largely a result of the financing markets becoming much more difficult to access for potential acquirers, particularly strategics. This slow-down in the exit markets may make it difficult for fund managers to raise capital because distributed-to-paid-in (DPI) has been such a crucial component of fund assessment over the past few years. In other words, GPs are increasingly trying to tackle the fundraising market with less validation of their strategy through partial or full realizations.

Who is Experiencing Success?: The fund managers that we are seeing achieve the most success in this volatile environment are the sector-focused groups that have the domain expertise to navigate choppier markets and the deep value players that have a focus on distressed assets, credit or a differentiated secondary approach. Real assets have also gained traction with infrastructure and timberland sectors seeing notable spikes. North American LPs continue to show strong conviction around domestic opportunities with high quality managers – even those launching spinout funds – and those GPs that have spent time off-cycle deepening and broadening their investor relationships will continue to gain traction and mind share from these forward-looking investor groups.

Next on 60 Seconds with Sixpoint: We will discuss how GPs are using co-investment to generate additional fees and broaden their LP base. What should your outreach strategy be when you have a deal that requires equity and/or debt co-invest?

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