A recent survey of private equity and venture capital managers showed competition was increasing among firms, pushing pricing levels up and making it harder to find attractive investment opportunities.
At the same time, it found an increase in investor appetite across the spectrum of limited partner types, and that the asset class was gaining prominence with investors outside traditional markets.
Preqin, an alternatives data provider, surveyed 260 private equity and venture capital managers in November about issues affecting their sector and their outlook for the coming year.
Fifty-four percent of managers said there had been an increase in competition for private equity transactions compared with a year earlier, while 39% said levels had remained the same.
Responses differed according to strategy. Sixty-six percent of buyout firms said they had experienced more competition, compared with 44% of growth firms that said this and 38% of venture capital firms.
Preqin noted that the increased availability of debt and growing dry powder levels would likely put pressure on pricing levels, possibly affecting returns.
The increase in competition and pricing would underscore the need for funds to develop different ways to create value, it said.
Forty-four percent of respondents reported that they were reviewing more investments opportunities than a year ago, while only 6% said they were reviewing fewer.
The vast majority of managers agreed that they were finding the market harder to navigate.
Thirty-seven percent of respondents said fundraising was their biggest challenge in the new year, while 32% cited valuations, 29% performance, 29% continuing volatility and uncertainty in global markets, 28% exits and 27% regulation.
Again, Preqin found that variation existed between firms with different strategies. Buyout firms, for example, were most concerned about valuations and regulation.
Venture capital managers said performance was their key issue — despite having generated the best one-year returns of any private equity fund type, indicating, Preqin said, that managers were feeling investor pressure to deliver consistent returns.
Bump-Up in Investor Appetite
According to the survey, 57% of managers said they had seen increased investor appetite, particularly among family offices, compared with a year earlier.
Sixty percent of family offices confirmed an increase in interest. In contrast, 12% of public pension funds and 11% of insurance companies had seen a decrease in appetite.
North America and Europe were the most prominent regions in which managers were looking for investments, noted by two-thirds of respondents in each instance. Thirty-six percent were scouting for investors in Asia and 21% in the Middle East and North Africa. Preqin said this showed the importance of less mature private equity and venture capital regions as a source of allocations.
The survey found that 53% of fund managers expected to offer more co-investment opportunities to investors in the coming year.
According to Preqin, this appeared to be a response to investors’ search for opportunities that offered lower fees, improved transparency and mitigation of the J-curve effect, in which returns first drop below initial value and later show profits exceeding the initial level.
Disruptive Regulatory Reform
Regulatory reforms are confusing to fund managers because of their uncertain effects, complicated laws and oft-delayed implementation dates.
Preqin asked fund managers how regulation would change the private equity landscape in 2015. Only 16% of respondents said it would change for the better.
Forty-five percent expected the worst, and 39% felt there would be no change.
Some respondents told Preqin that the increased bureaucracy complicated processes, and said fund managers were under pressure, especially from Dodd-Frank, the Foreign Account Tax Compliance Act (FATCA) and Europe’s Alternative Investment Fund Managers Directive (AIFMD).
Different firms with varying operating dynamics will be affected in different ways. Twenty-eight percent of growth firms expected changes for the better, compared with 13% of venture capital firms with this expectation and just 6% of buyout firms.
The chief concern of participants was cost of compliance, with 41% saying this was the main issue regarding AIFMD compliance.
Twenty-eight percent expressed concern about risks arising from uncertainty and lack of guidance around AIFMD, 26% about increased market complexity and 5% about confidentiality of information reported to regulators.
— Check out For Aequitas Capital, Small Firms Are the Sweet Spot on ThinkAdvisor.