Considering the record $523 billion distributed by fund managers to investors over the past calendar year – nearly 10 percent above the previous high of $477 billion set in 2014 – private equity has never been healthier. These four predictions forecast sustained appeal and continued growth for private equity, but they also enumerate challenging issues for investors and managers over the next 12 months.
Private Equity Assets Increase by a Double-Digit Percentage
Private equity’s assets under management have grown to $4 trillion from just $30 billion over the past two decades. Structural catalysts behind long-term growth – notably private equity’s micro focus and its lack of correlation with public markets – aided by today’s low interest rates, have set the stage for PE assets to rise by as much as 20 percent this year. Rising sums committed to the asset class by traditional investors like pension funds, as well as rapidly increasingly allocations from newer investors such as sovereign wealth funds and family offices will drive much of that growth. With an activist approach to value creation, private equity offers the promise of 10 percent-plus returns even in years when public equity markets put in a poor performance. My base case scenario is that private equity assets under management will double over the next five years, accounting for a significantly larger share of the globe’s professionally managed assets than today’s 5.4 percent.
Growing Numbers of Investors Launch Emerging Manager Programs
In 2016 as investors increasingly seek long-term solutions to investing high levels of distributions without lowering overall returns, they will follow leading lights like the California Public Employees’ Retirement System and the Canadian Public Pension Investment Board by launching emerging manager programs. The programs help promising, but generally small first and second-time managers scale up over time. In an industry likely to be characterized by relatively high prices for years to come – even if set to fall a bit in 2016 – investors are turning to less crowded niche investment spaces where pricing is better and teams are frequently just emerging.
Venture Capitalists Further Concentrate Investments
Top venture capitalists will continue paying up for investments, despite current concerns about startup price inflation. But they will further reduce the number of companies they invest with – a practice that really started in earnest in 2015. As well-regarded venture capitalist Josh Kopelman of First Round Capital says, “we understand that our conviction in our decisions needs to be meaningfully higher in order to invest at meaningfully higher valuations.” By extension this means that startups will also continue to stay private for longer, with the best using their increased funding to eliminate competition and dominate their sector long before an initial public offering.
The Creation of PE Vehicles for Individuals Accelerates
The Palico Survey mentioned makes clear the extent to which individuals are being courted by fund advisors. While 77 percent of private equity managers say they have solicited capital from high net worth individuals, an even higher 9 out of 10 say they plan to raise capital from HNWIs for their next investment vehicle. The trouble has been how to effectively access these investors. Pantheon and Partners Group, two giants of the funds-of-funds world with plenty of distribution muscle, recently launched vehicles aimed at tapping this market. Their blueprints, which involve partnering with registered investment advisers and defined contribution retirement plans, will be followed by other funds-of-funds groups in 2016. These new vehicles – combined with online marketplaces like Palico – will provide effective beachheads for accumulating substantial assets from HNWIs and, eventually, from non-accredited retail investors. Despite major challenges for managers when it comes to marketing, individuals – attracted by the same dynamics as institutional investors – increased their exposure to private equity 30 percent between 2013 and 2014, according to the latest data from the U.S. Securities and Exchange Commission.
John Denes – CEO – REO Capital, LLC