Investors plan to allocate more to private equity (PE) despite their concerns about the asset class, though their allocation strategy is changing, found a survey* to be released today (December 4) by PE secondaries manager Coller Capital.

Six in 10 limited partners—that is, investors—polled globally believe PE returns will fall as the market matures, while just 7% expect them to rise. Moreover, the vast bulk (89%) of LPs said too many weak general partners (GPs)—that is, PE managers—are being funded.

Moreover, two-thirds of European LPs and half of North American LPs believe that an over-supply of debt is leading to the financing of poor buyout deals and the over-leveraging of higher-quality deals in their own regions. But only 21% of Asia-Pacific respondents said the same.

Figure 1: Target allocations to alternatives
(Click for full view)

Demand for private equity has grown strongly in the past few years, making it something of a victim of its own success. This has led to investors being concerned about over-crowding and looking for assets in more niche areas such as private debt or venture capital.

Yet mainstream PE is still seen as attractive on a relative basis given the prevailing ultra-low-yield environment, and it remains in higher demand than hedge funds (see figure 1, above).

Four in five (82%) of LPs hope to generate more than 11% in annual net returns from PE portfolios in the next three to five years, and 17% are forecasting returns of over 16% (see figure 2, below).

Figure 2: LPs' forecast returns for PE
(Click for full view)

Accordingly, LPs said they would support more managers with larger commitments over the next three to five years. Four in 10 LPs plan to increase the number of GPs in their private equity portfolios in the next three years, while 21% plan to reduce it.

Moreover, half of LPs plan to increase the average size of their PE commitment to individual managers, while just one in 10 said they would reduce it.

China PE strategies

The Coller survey also showed continued strong demand for Chinese private equity assets.

Four out of five LPs surveyed globally have private equity exposure to China—through global funds, pan-Asian funds, or China-specific funds. And four out of five Asia-Pacific-based investors are planning new commitments to mainland PE in the next three years, as are 58% of North American and 51% of European LPs.

“Our on-the-ground research suggests there is significant interest in technology, media, telecoms, healthcare, education and manufacturing,” Zhan Yang, Hong Kong-based principal at Coller Capital, told AsianInvestor.

Figure 3: Routes to Chinese PE exposure
(Click for full view)

Meanwhile, the survey findings suggested there is a structural limit in LPs' approach to China PE funds. The proportion of investors committing to China-specific funds (as opposed to regional funds or funds-of-funds with exposure to China) now stands at around half of LPs. The report shows that this proportion is unlikely to grow (see figure 3, above).

Direct versus co-investing

The Coller report also touched on the themes of direct and co-investing. Between 2006 and 2012, it found that the share of LPs making direct investments had almost doubled but had not changed materially since then, remaining at about a third of LPs.

“This is a structural limitation as only investors of a certain size and with specialist knowledge can execute a direct investing strategy,” said Yang.

Co-investing, by contrast, has become increasingly popular, with the number of LP co-investors doubling over the last decade. In 2006, only one quarter of LPs made co-investments, compared with more than 50% of LPs today, the report noted.

* London-based Coller Capital conducts a twice-yearly Global Private Equity Barometer survey*. This edition polled 110 investors in PE funds in September and October, 40% of which were from North America, 40% from Europe and 20% from Asia Pacific.