Bilan together with Lyrique Private Equity is starting a series of articles on private equity, of which this is the first. It will look at current issues in private equity and follow the market with European investors in mind. In this article, we will explore some of the main features of today’s private equity market.

Bilan together with Lyrique Private Equity is starting a series of articles on private equity, of which this is the first. It will look at current issues in private equity and follow the market with European investors in mind. In this article, we will explore some of the main features of today’s private equity market.
For a long time private equity has been little understood. However, buyout funds, where most of private equity’s money goes, have outperformed public markets over the last 20 years in all major regions including the US, Western Europe and Asia-Pacific (Source - Bain & Company). Today private equity has roughly $3 trillion under management, of which $2 trillion has been invested and $1 trillion available for investment, the so-called “dry powder”. Private equity has become an asset class in its own right and increasingly investors make it part of their portfolio. Large and small investors are increasing their exposure to this asset class and have done well as a result.
Most private equity money goes into buyouts i.e. transactions, whereby profitable companies change ownership. In 2017 Preqin, one of the industry’s better-known data providers, counted 4’191 buyout transactions worldwide for a total value of $347 billion or $83 million per transaction. This is significantly less than at the peak in 2007, when buyout deals counted for $696 billion. This is reassuring as the industry is now probably more careful than before the financial crisis. Venture capital invests money into fast growing companies to finance their growth. There are many more venture investments than buyouts, around 11’145 with a total value of $183 billion. On the other hand, the average venture capital transaction is much smaller at roughly $16 million (Source Preqin). Private equity in 2017 represented 13% of the world’s M&A monetary volume and 8% of the number of deals according to Bain & Company. This does not seem excessive and can probably grow without disrupting markets.
The market has not only grown but it has also matured and become more efficient. Wild performance swings happen less, making it more predictable. Rather than trying to be lucky, the industry has developed tools like a very detailed “100 day plan” to make many aspects of its investee companies better. Furthermore, there is now a wide number of private equity houses with special strategies in different geographies. Worldwide there are now roughly 5’500 active private equity managers. The best known are very large firms like Blackstone, KKR, Apollo or Carlyle in the US and the likes of CVC, Apax or EQT in Europe. The largest of these firms have assets under management of several hundred billion dollars and have often sought a listing on an (American) stock exchange. Such firms have become large diversified asset managers. Others have sought specialization, which can take many forms. However, there are many smaller, entrepreneurial groups of excellent quality, who have an edge thanks to a niche strategy.
Such smaller groups are often focused on a narrowly defined geography, usually a country in Europe, or a limited number of states in the US. It can also be in specific industry sectors like financial services, or in different phases of the private equity life cycle like secondary transactions.

Carefully constructed portfolios across different segments and vintage years reduce risk because of diversification, and have out-performed public markets. The chart below illustrates the risk profile of some of the major categories within private equity. The highest median returns are found in secondary transactions, whereas funds of funds produce returns with little volatility but lower returns. Buyouts are attractive with relatively high returns and can absorb large amounts of money.

The world’s largest buyout fund was raised this year by Apollo and amounted to a whopping $25 billion. Top venture capital has traditionally been harder to get into, as funds were small and the best reserved to loyal existing investors. This may be changing as traditional venture capital is turning to growth with much bigger pots of money, the biggest being an astonishing $100 billion fund by Softbank’s Masayoshi Son.

Continued emphasis on ever-bigger (buyout) funds deprives small funds of investors. The returns from small funds can be very attractive, as they often prepare small companies for a sale to a strategic acquirer or by a larger private equity firm, willing to pay much higher multiples. There is also some evidence that smaller firms may weather a recession better than their larger brethren.

A responsible investor today should seriously consider private equity if he or she wants to build a properly diversified portfolio. Private equity has proven itself and with more than 5’500 private equity houses, there is enough choice. Unless an investor is especially skilled in a particular industry and has enough time, investing through private equity funds is the only way to get proper diversification. The asset class systematically provides access to smaller companies and to entrepreneurs with a proven governance system. Hence, private equity today makes a lot of sense.

 

 

 

Hans van Swaay
Partner
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