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North America in the Context of Global Private Equity Trends

It is hard to deny the ongoing strong interest in private equity amongst institutional investors, in particular. Investors see private equity as a way to generate significant long term returns, despite the current low return environment. North American investors continue to represent the largest pool of capital invested in private equity globally. There is, however, a certain level of fear that private equity market is nearing the top of the cycle as market is topping out and downside risk is increasing.

In terms of sectors, midmarket buyout funds in North America remain the main focus for investors, with a big interest in fund managers with strategies that drive operational improvements and buy-and-build strategies.

There also is an increasing interest in funds focused on specific industry sectors. Those of the most interest to investors are the funds operating in healthcare and technology industries. Infrastructure is perceived as a rather favourable sector in terms of private equity allocations, but mostly for Europeans, and not so much for North American investors. This indicates that the sector is still emerging, and those North Americans targeting infrastructure are more likely to do so outside private equity allocations.

Asian investors are more focused on retail/consumer strategies while North American investors are more likely to invest in sector-focused funds in general.

In regards to the energy sector, it continues to attract a strong interest from North American investors, but overall, the demand in the sector has declined. A lot of pension plans and sovereign wealth funds have been showing an increasing interest in the real asset sectors, specifically in Oil & Gas.

Distressed debt is another area of interest. It is considered to be much more established in North America than in other parts of the world. With a few distinct distressed strategies, the top three investors prefer are distressed for control, turnaround/restructuring and special situations.

Investors have been increasingly interested in private credit. This is largely driven by opportunities created by turmoil in banks caused by regulatory changes, as well as private credit seen as a potential source of yield in a low rate environment.

Mezzanine and opportunistic credit sectors are perceived as the most attractive areas of focus, as well as diversified debt funds that invest across the debt portion of the capital structure.

SR US 2

Secondary market continues to get stronger. Large investors are much more likely to purchase direct positions in secondaries than invest in secondary funds. Fund restructurings using secondaries are a relatively recent strategy. This is also attracting the attention of the SEC in terms of potential conflicts of interest.

Interest in co-investments also remains robust. Large investors, who tend to have more capital to deploy and greater staff resources, are very active in this space, and only few perform direct investments.

Interest in venture capital has been two-sided. North American investors remain very keen to allocate capital to venture, with endowments and foundations appearing to be more aggressive in targeting primarily early-stage vehicles. Early-stage funds and funds focusing on technology or multiple sectors remain the key investment targets. There is no interest in clean-tech focused funds and little interest in venture debt.

Many North American private equity portfolios are very mature, and as a result, North Americans are more likely to pursue niche strategies to complement their core portfolios.

As for emerging markets, here we can see a significant decline in investor appetite, largely driven by economic or political risks. Interest in both Pan-Asian and Asian country-focused funds has declined, although in the context of the other emerging markets, Asia does appear to dominate investor interest.

The most attractive region in the emerging markets is China. It is also the deepest of the emerging markets for private equity, with a large number of fund managers and investment strategies from which to choose. The year-on-year demand for India has also been noted, supported by hopes that the Modi government will be progressively welcoming to private equity.

Though sub-Saharan Africa has been referred to as the latest hot emerging market, the investor appetite for the region has not increased that much from last year. In fact, the demand for the two largest economies in Sub-Saharan Africa: Nigeria and South Africa, remains very weak.

In relation to Europe, the Nordic Region, Germany and the U.K. are considered to be the top three investment destinations. The attractiveness of the U.K. seems to have been impacted by Brexit – at least for investors outside North America. North Americans still have a strong intention of investing in the U.K. but the overall attractiveness of the U.K. in rest of the world has dropped significantly. The latter tend to have more preference for countries like France, Italy and Spain, with less of a focus on Pan-European funds.

Eastern Europe remains low on the investors’ radar, due to political tensions between Russia and the West.

In regards to the key terms for investors, the most important one remains the level of GP financial commitment to a fund. Interestingly, ESG and compliance do not appear to be of a very high priority amongst key investor considerations and criteria.

Some of the major concerns for investors is the fact that too much money was coming into all areas of private equity, and that private equity as an asset class might be at the top of the cycle. Purchase price multiples for middle market buyouts are still too high, which sparks another fear. An issue of transparency and disclosure in regards to fees, costs and fund allocation is another big concern.  Additionally, there is also some concern that large firms in the market are becoming asset managers, focused on growing assets under management rather than their key investment strengths.

In summary, one of the key trends is a significant increase in dry powder perceived as one of the major threats for the industry. Coupled with high purchase price multiples, this puts a dramatic amount of pressure on fund managers to put capital to work at what is likely the peak of the market cycle.

In addition, the fight to raise capital is getting more intense, especially among midsized firms. This could very well be one of the aspects to disrupt “business as usual”. On the topic of disruption, cyber-attacks and cyber-security are gaining an increased awareness in private equity space.

Another interesting trends is the emergence of new types of investor. It is believed we are going to see a tendency of public investors assessing the private equity market. An opportunity for the public to invest in this industry is going to have a significant effect on the market.

Today we see private equity firms and investors operating in an increasingly uncertain environment. It is important to have a balance between risk and opportunity, grasping buy- and sell- side opportunities, expanding into new markets and focusing on value creation in existing portfolios. It all has to happen whilst managing risks and complying with new policies. For many, the investment environment continues to be challenging, with regulatory/legislative difficulties and high valuations being the biggest priorities, especially for smaller firms. With this, creating value in private equity investments is becoming more challenging in continued macro-economic uncertainties.

Despite the uncertainly, the pressure and the obstacles, private equity continues to demonstrate resilience and sustained growth, and projections for the future of the asset class remains optimistic, in North America and as well as the rest of the key markets.

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