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Has Private Equity Become More “Public”​ Since the Crisis?


Written by: Julien Gervaz | Palico 

Since the downturn, PE has managed to gain steam and approach pre-crisis levels. Firms are now acquiring public companies at the fastest rate since 2008. In total, deals reached $180 bn globally in 2017 which amounts to almost twice the level of the previous year. This spike in public-to-private deal making represents the largest increase since 2007 and comes at a time when the sector faces pressure to allocate ever larger sums. According to Bain & Company’s Global PE report for 2018, the number of “public-to-private” deals reached 152 in 2017, up from 94 in 2016, and significantly closer to the record of 196 deals in 2007.

Private Equity’s resilience during the crisis has encouraged investments in the asset class

While the banking sector took on its fair share of scrutiny during the crisis of 2008, some of the criticism made of PE may have been hasty for a sector that showed its resilience during the great recession. A recent study analyzed the performance of nearly 500 PE-backed companies in the UK during the crisis of 2008, and found that firms with PE-backing were able to withstand the downturn better than their non-PE-backed counterparts. The study particularly highlighted PE firms’ ability to provide companies with 2 percent more equity and a smaller decline of only 4 percent in debt financing, and with fewer restraints, compared to non-PE firms. Furthermore, the study found that private equity-backed firms not only increased assets at a faster pace than the sample, but also managed to gain market share during the crisis. GP talent matters: their ability to manage these companies during economic downturns highlights their sheer competence, at the highest level.

Capital injections have experienced a shift towards private assets

Quite possibly the biggest change since the onset of the crisis has been the dramatic rise of private capital. In the U.S., private capital has surpassed public markets as the most popular way to raise money and has effectively “reshaped the financial landscape,” said Jason Thomas, director of research at Carlyle Group. In the U.S alone, $2.4 trillion in private capital was raised in 2017, according to the Wall Street Journal. This astonishing amount has only widened the gap first created in 2011 with public markets, which raised $2.1 trillion in 2017. The largest portion of the $2.4 trillion, totaling $1.6 trillion, was raised from private placements, which according to the Wall Street journal accounted for more than 40,000 filings. A fundamental factor driving capital to private markets has been the gap between the assets and liabilities of public pension funds. According to McKinsey, the gap sat at 4.3 trillion in 2017 with a funded status of only 67 percent. As public markets cannot provide the returns to fill this gap, pension funds have focused on private markets. According to Antoine Dréan, founder of Triago, this comes as no surprise given the historic delta of 1000 basis points private equity provides over the risk-free rate.

What’s next: a GP-LP realignment is approaching

Secondaries are experiencing a boom

Exit and reallocation options have been on the rise, pointing towards LPs’ increasing need for liquidity. Secondary trading has seen an incredible increase marked by a jaw dropping first half of 2018 which produced $36.7 billion in deal volume, a 26 percent improvement on H1 2017. According to Triago, competition in the secondary market has increased as ever-larger funds specializing in secondaries accounted for 27 percent of volume in H1 2018, a far cry from the 4 percent of volume brought in by specialists in 2013. Data also shows that tail-ends have also been a driver for secondary market growth, making up 60 percent of funds sold by number and an unprecedented 24 percent of funds by value during the first half of 2018.

Secondaries should be marked by a substantial growth in GP-led transactions. Activity such as tender offers and restructurings from GP-led secondaries hit an estimated $7 billion in the first half of 2018 and represented a record 26 percent increase in total secondary volume according to Greenhill Cogent’s first-half secondary volume report. If this activity continues its push, restructurings could even become part of future LPAs. As the strategies created in search of liquidity multiply, so will the technology developed to facilitate processes for GPs and LPs active on the secondary market. Innovation in platforms dedicated to secondary trading such as Palico’s online secondary marketplace will bring forward a period of much needed digital transformation.

 GPs will need to adapt to survive future LP demands

LPs leading the trail towards demanding better terms and transparency has increasingly become the rule. The most significant point of contention on the part of LPs has been the fee structures, as PE remains the most expensive asset class for LPs, according to Preqin. This may be due to the current bargaining power GPs have over LPs but as returns have been eroding, the traditional 2 percent in management fees is slowly becoming a thing of the past, as more and more smaller GPs are asking for 1.5 percent.

Besides concerns over fees, investor demands regarding disclosure and transparency remain important. A poll by Evestment and ACA shows that PE lags behind other financial sectors adhering to GIPS – Global Investment Performance Standards, LPs criticizing IRR as a measure of performance that tends to make returns look higher. With the explosion of data used across all sectors of the economy, PE firms will have to adopt technologies making their own data more readily available and digestible to LPs. Providing innovative solutions to LPs will be the future of an asset class that ironically is the main investor behind the companies developing them.

More information, transparency and liquidity, upfront fees decreasing…all these point to the modernization of PE. Ironically, with the increasing presence of eager HNWs and Family Offices offering smaller tickets, is private equity becoming more public?

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