Private equity fund managers will have to work harder to continue producing the high returns that investors expect from their sector, which has become increasingly competitive and is currently “awash with money”.
This was the view of private equity fund managers and institutional investors who spoke at last week’s AVCJ Annual Private Equity & Venture Forum in Sydney.
Rune Monk, a partner at Coller Capital, said: “Looking back over the past 10 years our industry did well compared with the major asset classes. But now valuations are higher and there are no cheap assets out there. Things are going to get harder.”
In addition to increased competition and a high level of uninvested funds, currently estimated to be around US$1.5 trillion globally, Monk said debt was freely available for deals and low interest rates were forcing all investors to look at alternatives.
However, according to Sheridan Lee, who chaired a separate session at the conference last Friday, this is exactly the sort of environment where good venture and PE managers can shine.
They can use their better contacts – “if they have them” – for deal greater flow and they can use their global reach to better explore emerging market opportunities.
Speaking after her session, Lee, the executive chair of third-party marketing firm Shed Enterprises, said: “It’s not really about the availability of capital in the current environment. There is a lot of money looking for deals. It is more about placing the investments in a solid long-term sustainable group of investee companies, either as equity or debt. It is more difficult to invest than raise money at the moment. And that’s probably a good thing for the underlying investors.”
According to the latest Bain & Company Global Private Equity Report, things have already got harder for managers. Global private equity market activity was down in 2016, compared with recent years.
The value of new investments, worth US$257 globally, was down 13.5 per cent compared with 2015. In the Asia-Pacific market the value of investments fell 26 per cent year-on-year.
The value of buyout-backed exits, worth US$328 billion globally, was down 23 per cent compared with 2015, and down 28 per cent compared with 2014. In the Asia-Pacific market the value of exits fell 24 per cent in 2016 to US$36 billion.
Private equity funds raised US$589 billion globally in 2016, down two per cent compared with the previous year. However, it was the sixth consecutive year of positive inflows into PE funds, raising concern that returns will come under pressure as the amount of “dry powder” accumulates.
Bain says asset prices are rising and competition is intense, including greater involvement by sovereign wealth funds from emerging markets, particularly China, and co-investment by superannuation funds and other institutional investors.
Acquisition multiples were high at more than 10 times EBITDA. A number of fund managers told Bain that pricing was the biggest challenge facing the industry.
However, on the critical metric – returns – PE funds in every region produced returns that beat public equity markets last year, maintaining the sector’s long-term outperformance. In the Asia-Pacific market PE funds produced an average nine per cent internal rate of return last year over a five-year investment horizon.
However, Bain says that with the industry becoming more competitive PE returns are slowly trending down.
Jonathan Zhu, the managing director of Bain Capital, says Bain is responding by putting more focus on operational improvements in investee companies to try and improve margins.
“We have more people on the operational side and where we can we are taking our companies global. We also have more boots on the ground looking for something out of the mainstream,” Zhu says.
Alicia Gregory, the head of private equity at MLC, says the last times the industry faced similar conditions MLC went into the US venture capital market, which was out of favour at the time because of the tech wreck in the early 2000s.
“It has proved to be our top sector for the pas six or seven years,” Gregory says.
“The task of making money is harder than it was a few years ago, so we have to work harder to find unique opportunities.”
Jeremy Tasker, an executive director at Macquarie Capital, says: “The world is awash with capital and it will remain so. The risk right now is overpaying for highly contested assets.
“PE managers will have to demonstrate that they can source differentiated opportunities as a way of avoiding that risk.”
Lee’s session was a debate between economic forecasters, including Alex Joiner, chief economist at IFM Investors, Jessica Irvine, senior economics writer for the Sydney Morning Herald, and Richard Yetsenga, chief economist at ANZ.
Lee quoted John Kenneth Galbraith: “There are two kinds of forecasters – those who don’t know, and those who don’t know they don’t now” and asked the room, by show of hands, who felt confident about the economic outlook domestically in the year of the Rooster. The majority were optimistic, and perhaps supporting of Josh Frydenberg’s observation during the week that “nearly every country in the world would swap its place for Australia’s right now”. The same group of conference delegates were less sanguine about the global outlook because there were too many uncertainties.
The panel discussed the global outlook, Australia’s economic health and the implications for markets – listed and unlisted. They agreed that President Trump was going to try to do what he said he was going to do … but with limited success.
Among issues discussed, that could effect global prosperity, were the new US protectionist dogma and the prospect of a US border tax on goods. Yetsenga proffered that the dismantlement of the TPP was not a disaster and Australia could be a beneficiary.
Nor was there any support amongst the panel for an impending China credit crisis. The audience was encouraged to ‘keep an eye China’ although no-one expected an escalation of a Sino/US trade war or an ensuing negative effect on the US tech sector.
There was much discussion of the likely makeup of the American Federal Reserve after Yellen goes, by this time next year, when the predominately academic representatives are be replaced by a batch of billionaires – possibly including the Trump-mooted JP Morgan chair Jamie Dimon. There was consensus that we can expect three Fed interest hikes this year and that the new Board of Governors will be more hawkish. However, there was disagreement on the panel as to the benefits of a Fed that sees its role as the guardian of big business. That lead to a discussion about the recent Trump administration’s announcement of its intention to rescind the Dodd Frank legislation – the implications of which continued to divide the panelists.
Another great debate, and one close to the hearts of all delegates, was the outlook for national domestic house prices. The bank economist and the journalist were sanguine, albeit for different reasons, and the fund manager rained on their parade claiming within the year that house prices were only going sideways – for the foreseeable future.
No-one was game to say whether stock markets would continue to rally. Or where the Aussie dollar might go. Or inflation.
Lee concluded the session with another quote, from her economics professor: “God created economists to make weather forecasters look good”.
– John Kavanagh