McKinsey & Co has produced a bullish report on private equity off the back of new research indicating returns may have been better than previously stated. But, the consultants warn, it will be more difficult to pick the best managers in the future as their track records will count for less.
The report published last week – “Private Equity: Changing Perceptions and New Realities” –says that work done by McKinsey using analysis developed in 2011 for the World Economic Forum shows that PE funds developed in the US since 1995 had “meaningfully” outperformed the S&P 500. The report says two research teams have subsequently reached similar conclusions. PE’s annual returns over the long term have beaten the public market by 300bps, the report claims.
However, changes in the PE world have meant that persistence of returns, where those with good track records retained good rankings, has waned. And, compounding the manager selection issue, dispersion between the best and worst remains high.
McKinsey predicts that limited partners are likely to increase their allocations to PE and new retail offerings from the PE general partners will likely add more funding from high net worth individuals.
The report says: “As a result, we believe the industry is on the verge of a new phase of growth in capital under management―though with the history of troubled data, the potential for other possibilities must be acknowledged. But where will this additional capital be deployed?
“There are several possibilities. One is that fund size will rise as general partners seek larger deals. A recent McKinsey analysis found no meaningful correlation between performance and either deal size or fund size. If the boom era’s megadeals prove successful and borrowing costs remain low, then more such large transactions are likely as the demand among institutional investors to deploy large amounts of capital continues to increase. Another possibility is that private-equity firms will look to more nascent markets and to adjacent asset classes. Finally, firms could expand the universe of potential targets simply by lowering their return expectations.”
The report concludes: “It remains to be seen if the next phase of private-equity growth can match the last boom. What does seem clear, though, is that limited partners will have to work harder and smarter to find top funds, and general partners will need to become better marketers of their unique abilities.”
Click here for the full report.