Market Views: Is private equity overcrowded?
After a decade of bumper asset growth, private equity is finally showing some signs of strain.
Now a $3.41 trillion industry, the asset class saw a decline in total capital secured last year, down 24% to $432 billion from a record $566 billion in 2017, according to a report by alternatives data provider Preqin. Investors in Asia Pacific are growing wary of private equity activities over the coming year, according to an S&P Global Market Intelligence survey.
Some believed the market might be peaking, as private equity funds become more willing to invest in recent deals at very high valuations. This has begun to concern some of the asset owners that private equity companies seek as limited partners; Hong Kong-based insurer FWD, for example, has voiced concerns that too much money might be chasing too few deals.
Warren Buffett, famed investor and chief executive officer of Berkshire Hathaway, has also expressed his doubts about buying companies now. He noted that “prices are sky-high for businesses possessing decent long-term prospects,” as private equity groups compete with each other and his company for mega-buyout opportunities.
Still, many investors remain eager to pour capital into the asset class. China Pacific Life Insurance, the third-largest life insurer in China, is expected to ramp up its exposure to the asset class through investments in companies in their later stage of development.
Given these mixed market views, there is no consensus among investors about whether the sector has attracted too many competitors, and if it remains a good time to put money to work in private equity funds.
AsianInvestor asked four specialists for their perspectives over whether 2019 would be a fair year or foul for private equity, and which strategies potential limited partner (LP) investors should favour.
The following extracts have been edited for brevity and clarity.
Wen Tan, co-head of private equity – Asia Pacific
Aberdeen Standard Investments
The Asia private equity industry is experiencing a deluge and drought simultaneously. Capital is flooding into the largest private equity funds, which can absorb the size of cheques being written by pension and sovereign wealth funds. At the same time, newer investors are also gravitating towards the largest brand names because they lack the experience to find value themselves.
This has caused a drought for general partners (GPs) at the smaller end of the market…many experienced GPs who have spun out of larger organisations to raise smaller, more nimble funds are struggling to attract capital. Yet this is where we see stronger return potential because of market inefficiencies.
One challenge that investors are facing globally is the decline in consistent fund performance. Data now shows the likelihood of a GP producing one first-quartile fund and following that up with another first-quartile fund to be less than 25%.
In Asia, this is exacerbated by a rapid step-up in fund sizes and high turnover among private equity teams.
A trend from the US and Europe that is catching on in Asia is the growth of funds specialising in buying stakes in GPs. We are also seeing a rise in long-dated funds, with investors choosing longer holding periods to maximise value creation rather than funds with more limited life spans. Separately we see investor interest increasing in impact investing.
Additionally, we are seeing investors seeking to consolidate the number of GP relationships they maintain and monitor…this will cement the rise of “pan-alternatives” managers who can provide tailored mandates across private equity, private debt, infrastructure and/or real estate.
Roderick Lai, consultant, corporate M&A and private equity
Eversheds Sutherland
People feel that there is overcrowding because there has been (and there continues to be) a lot of competition for certain assets in the market and … a lot of upwards pressure on prices. This competition is particularly strong in the “hot” areas – technology, healthcare, education, fintech.
For instance ... we see our clients looking at and doing deals in and around China, India and South East Asia – particularly, Malaysia, Vietnam and Indonesia. These are all developing economies with high economic growth.
There are obvious challenges for doing deals in these markets in terms of stability, legal certainty and governance, but there are good businesses with great management teams to be found out there.
The investment [plans] supporting these deals are developing as well … we are increasingly seeing our PE clients make investments supporting Asian businesses and brands to expand both within the region and also into markets in Europe and the Americas.
We are also increasingly seeing clients looking at different deal types or structures. For instance … we are seeing more clients looking at buy-outs, secondaries and [other] control-type deals … we have PE clients taking more down-side protection by structuring their deals using convertible securities and other instruments.
As we enter a period of macro-economic and geopolitical instability…our clients [are also] looking at businesses that are “recession-proof” or at least more “recession-resilient”.
Cyrus Driver, head private equity Asia
Partners Group
The past year has seen private equity valuations rise yet again from an already high base. We attribute this to ever-increasing competition from private equity managers, strategic buyers and new market entrants, encouraged by the search for yield while interest rates remain low and by strong debt markets for leveraged buyouts.
Quality assets typically trade at Ebitda multiples in the mid-teen range. In contrast, assets still trading at low multiples tend to be underperforming or operating in highly cyclical sub-sectors. We maintain our belief that … private markets investment managers have no option but to excel in their value creation capabilities.
In terms of sectors, we continue to see attractive opportunities in the healthcare and business services sectors globally. We see interesting opportunities in automation and technology hardware in Asia and emerging markets and hence have upgraded industrials in the region, but remain neutral on the sector overall due to the tariffs levied on capital goods.
Similarly, we underweight information technology in Asia and emerging markets due to concerns around the sustainability of cross-border demand. Given overstretched valuations, we are cautious about the media/telecommunications sector in the US.
Examples of investment themes that have enabled us to successfully source recent investments include the growing demand for digital product engineering services, industrial consumables, outsourced manufacturing and discount retail.
Michael Mills, managing director, alternative products
Value Partners
From what we can see, the Asian/Chinese Venture Capital space is probably overcrowded.
The number of deals and deal value of Asia already exceeds the same amount for North America and is double that of Europe. Yet when you look at the private equity space in Asia, the number of deals and deal value of buyouts is around one-fifth of Europe and one-tenth of North America (based on Preqin data).
If you move beyond tech-focused and venture capital strategies, then there are various strategies that are still underdeveloped in Asia/China … Considering the [education] sector is 5% of Chinse GDP, yet healthcare is 6% of GDP – we think this is a sector of opportunity.
In addition, whereas growth and large buyouts are typically a focus of Chinese/Asian private equity, midsize buyouts are not really a focus of most private equity funds. So this an area of expansion we would expect to see occur going forward.
A big concern we have seen from investors into Asian/Chinese private equity is that although there have been sufficient deals for the various private equity funds, exits and the return from these exits have lagged. Therefore, the focus on the completion of deals, creating exits and generating returns will be a trend that will have a significant impact on the industry in the long run.
This article was updated to clarify Roderick Lai's contribution.