Tim Jenkinson indulged in some educated crystal-ball-gazing at the end of this year’s Oxford Private Equity Programme.
The sector will continue to grow
The financial crisis created problems for many different asset classes, but Private Equity has had a pretty good decade.
No doubt quantitative easing has helped – and as interest rates start rising, firms will find that some of the easy tricks to be played with very cheap debt are going to disappear. On the other hand there is still a lot of debt available and I don’t really see that changing in the near future. Interest rates will return to a more normal level, but slowly, and it will not feel particularly disruptive.
Mind you, if Private Equity has had a good 10 years so too have public markets. Anybody who has been in the S&P 500 for the last 10 years has done well. In theory this convergence of levels of return is a challenge to private equity, though it doesn’t seem to have made much difference yet to investment levels.
So all the signs are that the sector will continue to grow. Because it is a buy-to-sell model the stock is surprisingly small – only around one or two per cent of investable assets in the world are in private equity. Surveys indicate that investors want to increase funding to private equity; there are all sorts of new players coming into the field; and a lot of innovation and secondary dealing. Commitments will grow and that will lead to a growth in the stock of assets. There is always some going in and some going out but in equilibrium I think that stock is going to double or treble.
It will spread to emerging markets
The spread of private equity to emerging markets has been slower than many predicted – and that includes me. The problem was that many of the early deals did not go very well, and investors found it difficult to get their money out.
The big funds in particular have found it quite difficult to go into the local market, with the result that the winners in places like China will be the local GPs, who may have trained with big firms such as Blackstone’s, but set up on their own locally and have a good track record and plenty of local contacts.
Development finance institutions such as EBRD (European Bank of Reconstruction and Development) play a huge role in developing private equity in emerging markets by giving political cover, preventing governments reneging on deals – which is, of course, one of the biggest worries to investors. It is important, too, to persuade local institutional investors to join the ecosystem. This is something that the International Development Association is working on. Why, after all, would international pension funds invest if the local pension funds are not doing so?
We have reached ‘peak co-invest’
The current fashion for direct investing and co-investing I see as mainly an attempt to get the cost of private equity down. And it doesn’t really work because there are different skills involved.
Some interesting co-investment clubs have been set up which I think make a lot of sense: 20 investors agree to share their co investment opportunities and use a specialised intermediary who actually executes them. But that’s not the same as a couple of small pension funds getting together and thinking they can not only provide the funds but manage the transaction too.
Fees will go down, but gradually
I think that the pressure for lower fees will eventually bear fruit, especially for the big funds. However, it will be very, very gradual.
My prediction is that, as a result, some GPs will just get fed up with co-investment. They will say, ‘Look, we are good at what we do, so we don’t really need co-investment – it is a pain in the neck. And if you don’t like it you can go somewhere else.’
The fund model will survive
As Winston Churchill said about democracy: it is the worst system, except for all the other systems that have been tried. Funds have their flaws but they are less bad than the alternatives.
I think there will be some experimentations with fund life, and they will include the big US GPs launching permanent capital vehicles. But my hunch is that the returns from those will disappoint.
Fund of funds will return
This is probably my most radical prediction. I know that fund of funds hasn’t been flavour of the month for a while. But there is a lot to be said for giving people the ability to set up diversified portfolios that you share across investors. It has always had a rationale: the problem was that it was expensive. But the fees are coming down, the structures are quite good … you tack on their ability to co-invest, and I think they have a role to play in the ecosystem in the long term.
But niche players will survive
The big players are going to do very well but they will not take over the entire market. Plenty of LPs will be wary of them, especially as they go public, the incentive schemes get less, and they basically become financial institutions. Many people prefer the original cottage industry style of private equity, which was about knowing your sector and knowing your geography.
So niche players will survive – and by niche, I don’t necessarily mean small. I would call CBC a pretty focused player and yet they are raising 50 billion Euros: people who simply stick to what they are doing will make good money in this area.
There will continue to be plenty of talent
It is a very attractive industry, and there is no shortage of young people wanting to work in it. I see this at the front end with our MBA students. If you ask MBA students which industry they most want to work in, they don’t say investment banking anymore. Some are still keen on consulting but many, many of them want to get into private equity.