Andrew Lebus, Manager, Pantheon International Participations
Private equity investment, even in a subdued but more stable global economy, continues to favour investors who play the long game: active management, discipline in pricing, diversification, and thematic investment based on long-term trends, particularly demographic ones. These are key attributes in our selection of successful private equity managers.
The global economy has entered a phase of slower growth. In both the US and more slowly in Europe, we appear to have moved beyond crisis and perhaps into recovery, but growth will not be buoyant for a long time. In those emerging markets where private equity is most well established, China, India and Brazil, growth has stepped down to a lower plane. We therefore target sectors expected to benefit from cyclical recovery such as manufacturing, technology and housing in the US, as well as more secular opportunities driven by demographic trends such as restructuring and healthcare in Europe, and consumption, education and healthcare in emerging markets.
The US remains the largest and deepest private equity market and where the majority of PIP’s portfolio is invested. On several measures, the industry in the US seems to have attained something like a new interim steady state, activity levels having returned to more normalised levels. Private equity investment increased in the US in 2012 and we are starting to see signs of a pick-up in general M&A activity.
When it comes to the exit environment, IPOs are recovering in number and value. The outlook for trade sales continues to look encouraging given the trillions of dollars on balance sheets of US companies much of which will need to be deployed in productive investments.
There are also signs of increasing stability in the European private equity market although the situation differs greatly from country to country. Adding value operationally, capitalising on social and economic change, and concentrating investment in regions where the banks are more resilient offers a navigable path to good investment performance in Europe. Where there is less resilience, such as in Spain and Italy for example, there is less opportunity currently – although from time to time there will be isolated worthwhile opportunities. These large southern European economies are not likely to become more universally attractive again until local banks recognise that the assets on their balance sheets will need to be marked down paving the way for a quicker recovery.
The more robust Northern European economies are well-positioned to benefit from export-led growth and are less pressured by the weight of sovereign debt and weak consumer spending.
Elsewhere, in emerging markets where growth – despite the slowdown – is stronger, it makes sense to concentrate on the fundamentals. These include solid execution of deals, good attention to detail, not investing too much just because the local market is hot, and diversification. In China where there has been a proliferation of managers, selecting the right managers demands great resources, relationships, experience and patience.
Currently PIP focusses on more mature investments, buying secondary interests in funds that have already begun investing, and co-investing in new investments alongside the private equity manager.
The market in secondary interests in private equity funds has seen a surge in activity as more institutional investors look to sell-down assets. Regulatory developments have been pushing financial institutions to divest their private equity holdings and many institutional investors are taking a more active approach to portfolio management by selling some of their private equity fund interests before maturity. We anticipate further opportunities to buy attractive assets at a discount to fair value over the course of the coming year.
Through our extensive relationships with private equity managers worldwide, PIP’s opportunity to co-invest alongside managers is boosted by a generally higher equity requirement in transactions, exacerbated by constraints resulting from a challenging fundraising environment. The cost advantages of co-investments (typically low or no fees charged by the private equity manager), offers the potential to enhance returns.
Overall, we believe the current climate can provide opportunities to create value by investing with discipline in businesses at attractive valuations, capitalising on certain pockets of higher growth and exploiting market dislocations. This provides a strong foundation for continued good performance from private equity.