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PRIVATE
EQUITY
NAVIGATOR
Private Equity Analysis from INSEAD’s Global Private Equity Initiative
April 2015
ABOUT US
INSEAD GLOBAL PRIVATE EQUITY INITIATIVE
PEVARA
(www.insead.edu/gpei)
(www.pevara.com)
The Global Private Equity Initiative (GPEI) drives
teaching, research and events in the field of
private equity and related alternative investments
at INSEAD, a world-leading business school. It
was launched in 2009 to combine the rigour and
reach of the school’s research capabilities with
the talents of global professionals in the private
equity industry. The GPEI aims to enhance the
productivity of the capital deployed in this asset
class and to facilitate the exchange of ideas and
best practice.
Pevara is a division of eFront (www.efront.com),
a leading software provider of end-to-end
solutions dedicated to the financial services
industry with a recognized expertise in alternative
investments, enterprise risk management, and
customer relationship management. eFront’s
solutions serve more than 800 customers in 48
countries, including companies in the private
equity, real estate investment, banking and
insurance sectors. eFront’s primary product suites
offer tightly integrated solutions for streamlining
the management of alternative investments and
corporate risk. Founded in 1999, eFront services
clients worldwide from offices in Asia, Europe,
the Middle East and North America.
Pevara’s data is obtained from actual LP cash
flows as opposed to surveys or relying on the
Freedom of Information Act to source data. LPs
who wish to contribute data to the Pevara Private
Equity Index can do so by sending an email to
[email protected], after which a Pevara data
specialist will discuss the process with them.
INSEAD's global presence – with campuses in
France, Singapore and the UAE – offers a unique
advantage in conducting research into established
markets for private equity, while at the same time
exploring new frontiers in emerging markets to
arrive at a truly global perspective on this asset
class. The GPEI also focuses attention on newer
areas shaping the industry such as impact
investing, growth equity, infrastructure PE, and
specific groups of LPs like family offices and
sovereign wealth funds.
The GPEI looks to partner with stakeholders in
the private equity industry to collaborate on
research ideas and projects. Its core supporters are:
This report is authored by Michael Prahl, Executive Director of the GPEI, Adjunct Professor of
Entrepreneurship and Family Enterprise and Siddharth Poddar, Research Associate, under the
supervision of Claudia Zeisberger, Academic Director of the GPEI, Professor of Decision Sciences
and Entrepreneurship and Family Enterprise at INSEAD. We thank Rishi Kotecha from Pevara, Bowen
White, Senior Researcher GPEI and Hazel Hamelin, senior editor at INSEAD, for their invaluable
support.
INTRODUCTION
Welcome to the sixth edition of the Private Equity Navigator.
This edition introduces a new format in response to feedback from our readers. Adding to the
quantitative reporting on the state of the private equity industry in previous issues, we have included
sections that highlight the latest research by INSEAD’s Private Equity Centre, as well as PE-themed
teaching and events at INSEAD.
Henceforth, the report will be published biannually as opposed to quarterly, but each issue will have
enhanced PE content, providing more substance for readers to think about. We will continue to
expand our collaboration with Pevara, the performance monitoring module of eFront, a leading
financial analysis solution for alternative investments.
The new format allows us to include new content in future issues, such as interviews with PE thought
leaders, activity updates from students and the alumni PE Club, and opinion pieces by leaders in
industry and academia.
We have enjoyed putting this redesigned edition of the report together and hope that you find it
more relevant and engaging. As ever, we welcome your feedback and suggestions.
Claudia Zeisberger
Michael Prahl
Affiliate Professor of Decision Sciences and
Entrepreneurship and Family Enterprise,
Academic Director, GPEI
Adjunct Professor of Entrepreneurship and
Family Enterprise,
Executive Director, GPEI
1
INDEX
The Private Equity Navigator seeks to balance the presentation of raw data and minimal accompanying
commentary with a more engaging (if less rigorous) approach to illustrate key concepts in private
equity. Our findings are presented in five sections:
01 The PE Industry in 2014
02 Detailed Market Analysis - INSEAD & Pevara Database
03 PE News @ INSEAD
04 Research by INSEAD’s PE Centre
05 Insights from GPEI's Model Portfolios
2
The PE Industry in 2014
Long Term Outperformance
of PE
Looking back on 2014, what stands out is how
little the PE industry seemed to be impacted by
major political and macro-economic
developments. Indeed, on most dimensions the
trends established in previous years continued.
On a more positive note, our research shows
that PE has been outperforming public markets
consistently over almost any period (not just the
“good old days” of the 90s) and in most
geographies. Our comparisons use Modified IRRs
(which, unlike IRRs, take into account a reasonable
re-investment rate and timing of capital calls) and
regional small- and mid-cap indices (a more
relevant comparison, we think, than the frequently
used S&P500, where companies have a median
market cap of USD18 billion). As an example, over
the 10 and 15-year time horizons, global PE net
returns outperformed by 4 and 6 percentage
points respectively.
Seller’s Market
Buoyed by strong public markets, cash-rich
corporate buyers and well-funded PE competitors,
2014 was the fourth year of an exit “super cycle”
(if 2010 can be regarded as reaching pre-financial
crisis normal), with PE funds returning record
amounts to their LPs.
(No) Capital Overhang
On the back of strong distributions and returns,
PE funds continue to raise large amounts of fresh
capital. While sizable in absolute terms (about
USD1.1 trillion) the proportion of ‘dry powder’ to
the USD3.8 trillion in assets currently under
management in the PE industry has in fact
decreased. Given that even the record amounts
of funds raised in 2006-2008 have worked
through the system and generated acceptable
returns (if not always in time value, at least mostly
in returning capital plus), the eternal dilemma of
“too much capital chasing too few deals” seems
– at least for the time being – not to be driven
by the supply side.
The Case for Diversification
While the industry’s performance has been strong
overall, there exists significant variance between
vintages, geographies, investment styles and –
on a micro level – certainly between managers
(e.g. fund returns for European managers in our
sample ranged from +32% to -12% for fund
vintages 2001-2011). The challenge for investors
in this asset class, therefore, is how to balance
the need for reasonable diversification against
the cost of assembling the in-house skills to invest
and monitor such a portfolio. A related problem
in this environment of high distributions is
investors’ ballooning portfolios, as LPs put capital
to work in new fund allocations (one of the trends
behind the current investor interest in coinvestments).
Investment Activity at Low
Levels
The problem rests squarely on the demand side,
where PE buyers have to compete with an
extensive range of substitute financing offerings.
The liquidity injected into the global economy is
leading to high purchase multiples supported by
extremely generous debt financing (although not
evenly spread across all geographies or
segments of the market). Overall deal activity
remains, for the second year in a row, at 2009
levels (i.e. the era of the global financial crisis).
Accordingly, the theme of INSEAD’s forthcoming
PE conference - “How to create value for investors
when faced with high valuations” – could not be
more appropriate.
Does 2014 rhyme with 2007?
As we enter 2015, signs are emerging once again
that markets are nearing a cyclical peak. In 2007,
Citigroup’s then CEO Chuck Prince famously
remarked about leveraged loans: “When the
music stops, in terms of liquidity, things will be
complicated. But as long as the music is playing,
you’ve got to get up and dance. We’re still
dancing.” Let’s hope that, eight years on, a more
disciplined approach to deploying capital will
help the industry weather the upcoming
challenges more effectively.
3
Detailed Market Analysis –
INSEAD & Pevara Database
The following pages provide
an update on the PE market
in 2014. With Q4 distribution
and capital call numbers in,
we are able to review activity
levels for the year. We
examine recent returns of
the industry against longterm trends and, more
importantly, vis-à-vis public
markets for a gauge of the
industry’s proposition of
outperformance.
4
PE Market Update (Activity
in Q4 2014 and Full Year 2014)
In the first part of our analysis we look at two key
indicators of private equity activity, namely the amount
of capital called by fund managers and the amount of
capital distributed to investors. For reference, the graph
includes fundraising numbers up to 2012.1 The data
come from 2,470 private equity funds, a more-thanadequate proxy for industry activity levels and
variations.2
A seller’s market in 2014, distributions continuing at twice the rate of capital calls
distributed each year. The tide turned the following
year; just as investments dried up following the onset
of the financial crisis, distributions started rising.
From a broad parity in 2010 and 2011, distributions
soared to 2.3x and 2.4x of capital called in 2013 and
2014 respectively. This means that in 2014 funds in
our sample called $110 billion while distributing a
whopping $259 billion – both figures largely
unchanged from 2013.
Overall it is interesting to observe that the pace of
capital calls (i.e. investment activity) is significantly
steadier than distributions (and fundraising) and exhibits
only a very short valley (effectively 2009). This surely
points to the industry working through overhang
problems from fundraising and investments prior to
the financial crisis (or, framing it more positively, to PE
firms’ patience and ability to wait for a positive exit
environment), but may also indicate the problems the
industry faces in deploying capital at a faster pace in
the current QE environment.
Between 2006 and 2010, the amount of capital called
by fund managers in our sample exceeded the amount
Major slowdown in deal activity in Q4 2014
The aforementioned gap between distributions and
capital calls became even more pronounced towards
the end of last year. Distributions in the fourth quarter
($66.1 billion) were down slightly, by about 5% on
both a year earlier and the preceding quarter,
reflecting the continued strong appetite of strategic
buyers, public markets and other PE funds. Yet
investment activity dropped off sharply to $21.4
billion, down 40% year-on-year and 28% compared
to Q3 2014. This means that in Q4 2014 funds
returned 3 times more capital than they called. We
will continue to monitor activity to see whether this
is just a quarterly blip or a long-term trend.
$150 billion raised vs. $259 billion distributed, or a
ratio of 1.72.
Capital called and distributed in the last 6
quarters
Fig 2
80
70
60
50
40
30
20
Perhaps a better comparison than between current
capital calls and distributions is that of funds raised
in the past and current distributions.3 If we go back
5.5 years to the last two quarters of 2008 and the
first two quarters of 2009, the figures are as follows:
10
0
Q3 ‘13
Q4 ‘13
Q1 ‘14
Calls
Q2 ‘14
Q3 ‘14
Q4 ‘14
Distr.
1 The amount of capital raised is measured for funds of that vintage year, as opposed to the total amount of capital raised in a particular year. We
do not use 2013 and 2014 numbers in this instance as complete data on the amount of capital raised by those vintage funds is, as yet, unavailable.
2 While the PE industry is larger and the data in this report is a representative proxy, the advantage of our dataset is that it is obtained directly
from LPs, and is hence more accurate than data obtained from a range of other sources.
3 We do not have access to portfolio company level data that would allow us to perform this matching exercise on a more granular basis, yet
we know from a variety of sources that average holding periods in the last few years have been 5-6 years.
5
North America is by far PEs largest and most liquid market
Breaking down the numbers by region, North American
funds continued their strong showing from 2013 (not
surprisingly), producing capital calls worth $60.1 billion
and distributions worth $165.7 billion in the year. In
fact, PE industry capital calls and distributions in 2014
remained largely unchanged in all geographic regions
from 2013 levels, aside from a significant 70% increase
in capital distributions by Asian funds, rising from $10.3
billion in 2013 to $17.5 billion in 2014.
Fig 3
Over the last five years, North American funds
cumulatively called $468.4 billion and distributed
$703.9 billion, accounting for 59% and 69% of the
global total respectively. Europe accounted for a 34%
global share of capital called and 27% of capital
distributed between 2009 and 2014, while Asian funds
accounted for 7% of capital called and 4% of
distributions.
Fig 4
Geographic share of capital called (2009-2014)
Europe 34%
ia
As
Geographic share of capital distributed (2009-2014)
Europe 27%
North America
59%
Asia 4%
North America
69%
7%
PE Returns & Variance
In this section of the report we compare three different
measures of annual private equity performance. The
first is the internal rate of return (IRR), the conventional
but theoretically unsound performance measure of
the industry. 4 Second, the Pevara Index, which
calculates IRRs using the Modified Dietz Method, which
improves on the IRR by accounting for the timing of
cash flows within a period. And third, the modified
internal rate of return (MIRR), which is our preferred
measure as it assumes more realistic re-investment
opportunities for investors,5 thus providing a better
gauge of performance. We also offer an analysis of
quarterly PE performance, followed by a geographic
analysis of PE returns and comparisons with the returns
provided by the public equity markets.
Despite strong realisations, a drop in returns
market of prior years), or, more worryingly, a sign of
deteriorating quality as a result of PE firms aggressively
exiting better performing investments and leaving less
attractive portfolio companies in their portfolios.
In the third quarter of 2014, the private equity industry
recorded MIRR returns of 1.00%, a marked decline
over the 4.25% return generated in Q2. The MIRR also
fell sharply year-on-year – from 4.24% in Q3 2013.
Over the whole of 2014, private equity returns
(measured in MIRR) fell from 16.48% to an estimated
8.91%.6 This is comparable to 2011, when the slowdown
in the global economy was in evidence. Post-crisis,
2014 was also the only other year (after 2011) in which
the industry generated sub-10% returns.
Fig 5
Annual PE returns
What is striking is that this shortfall in performance
occurred despite the year’s aforementioned strong
realisations. This is likely the result of PE firms exiting
older investments at low time-weighted returns, as
well as the NAVs of remaining portfolio investments
growing at a slow rate.7 The latter could be both a
function of accounting (i.e. valuations of public market
comparables changed less last year than in the bull
The two main issues with IRR, namely the re-investment hypothesis on intermediary distributions and the cost of uncalled capital, are discussed
in detail in the December 2013 issue of Private Equity Navigator.
This report uses a discount rate for capital calls of 12% with a 10-year horizon, and equally assumes that proceeds will be reinvested at a rate
of 12%. For more details, refer to the December 2013 issue of Private Equity Navigator.
6 Our 2014 numbers do not yet include NAV adjustments for Q4 which are going to change the final number. However the realizations for the
year and NAV adjustment of Q1-3 point to a substantially lower run rate than previous years.
7 Performance is unlikely to be strongly impacted by a wall of fresh investments held at cost, given the subdued investment activity of the last years.
4
5
6
10-year returns are strongest in Europe, while 2014 was a catch-up year for Asian funds
The 10-year MIRR of the private equity industry is useful
for comparing the performance of the asset class
across different regions as it incorporates more than
an entire economic cycle.
per annum, which is largely in line with the global
average return provided by private equity funds (11.83%).
Asian fund performance lagged the global average
over the last decade, providing an average return of
10.2%. However, Asian funds were the best performers
in 2014, generating an MIRR of 11.48%, compared to
8.9% for Europe and 8.7% for North America.
The average MIRR return over the last 10 years was
highest for European private equity funds, at 13%. North
American funds provided an average return of 11.77%
Fig 6
A year-by-year comparison of returns by region reveals
that Asian returns deviated from the global benchmark
more significantly than returns provided by funds
investing in the mature markets of Europe and North
America. For instance, returns from Asian PE stood at
19.4% immediately following the onset of the financial
crisis in 2009, as compared to 7.1% in Europe and 11.2%
in North America. However, when PE returns fell during
the slowdown of 2011, Asian funds produced the only
negative results – generating a return of -1.8% that
year, while funds investing in Europe and North America
generated positive returns of 7.7% and 9.3%
respectively. This is likely due to the fact that PE
investing in Asia continues to differ significantly from
that in mature markets, with a heavy focus on growth
capital and small buyouts.
MIRR comparison by geography
PE has outperformed public markets across geographies and time horizons
To get a clearer sense of PE performance, we compare
MIRR performance8 with public market returns (in this
case, the MSCI ACWI). 9 Global PE returns are
substantially stronger than public market returns across
both the 15-year and 10-year time horizons (by 6 and
4 percentage points respectively), but only 2
percentage points higher over the five-year period to
2014. In 2014, while the PE industry recorded a
preliminary MIRR of 8.91%, returns from the public
market index stood at 4.71%.
Fig 7
15y
Fig 8
15y
Global PE and public market returns
10y
PE and public market returns - Europe
10y
5y
In Europe, the return on public equity since 2000, as
measured by the MSCI Europe SMID Cap Index,10 was
6.27%, while the private equity MIRR during this period
was 11.45%. Over a 10-year horizon starting in 2005,
both public market returns and private equity MIRR
increased, to 7.13% and 12.18% respectively. Post-crisis,
the public market index performed in line with private
equity, providing annual returns of 10.21% compared
to 10.14% for private equity.
5y
Let’s look at these comparisons using relevant smalland mid-cap indices to provide an in-depth analysis
of performance across the key regions.
Unlike IRR the MIRR can be used for comparison with public markets as it accounts for the cost of capital until investment and assumes
reasonable re-investment rates (we use a reinvestment rate of 12%). For a discussion of the qualities of MIRR please see our inaugural Private
Equity Navigator as well as the glossary provided.
9 The MSCI ACWI was used for reference only. The index has 2,471 constituents from 23 developed markets and 23 emerging markets and it
covers approximately 85% of the global investable equity opportunity set.
10 The MSCI Europe SMID Cap Index covers small- and mid-cap representation across 15 developed markets in Europe. The index has 1,152
constituents and covers approximately 28% of the free float-adjusted market capitalisation in each country.
8
7
Fig 9
15y
during this period, providing an annual return of 8.41%
compared to public market returns of 3.93%. In addition,
while the public market slightly outperformed Asian
PE returns over a 10-year period, at 9.89% and 9.35%
respectively, Asian PE firms broadly outperformed the
public markets since 2000, generating an MIRR of
9.96% compared to a public market return of 6.60%.
PE and public market returns - North America
10y
As these graphs show, public market returns are more
prone to larger swings in annual performance, resulting
in far greater volatility than the PE asset class. However,
this is due, in part, to PE firms’ delayed and more
conservative accounting, while public markets reflect
real-time returns.
5y
The MSCI North America SMID Cap Index11 produced
strong returns of 14.08% over the last five years, as
compared to the 11.62% MIRR generated by North
American PE. Over the 10-year period starting in 2005,
private equity MIRR stood at 11.18%, somewhat higher
than the 9.24% returns provided by the public market
index. This relatively small difference remains stable
over the longer period since 2000: North American
PE returns stand at 9.26% while the public index
produced annual returns of 8.39%.
PE and public market returns - Asia
Fig 10
Asia is the only major region where PE MIRR returns
over the last five-years were higher than the returns
from the public market index (as measured by the
MSCI AC Asia ex Japan Small Cap Index). In fact, PE
outperformed the public markets quite significantly
15y
10y
5y
PE investing in Europe had the highest range of outcomes
Now we look at the variance in private equity returns
performance by geography.
those returns, as some of the European funds of these
vintages are also the worst performing. Moreover, the
pooled mean return for European funds is lower than
North American funds, implying that the latter provided
the best returns on a risk-adjusted basis.
The chart shows the range of returns by geography
for all private equity funds in the Pevara Index of
vintages 2001-2011.12
Fig 11
At the global level, funds vintages of 2001-2011 have
a pooled mean of 9.8%. Only North American funds
outperform this measure, with a pooled mean of 9.95%.
Funds of the same vintages investing in Europe and
Asia have pooled means of 9.78% and 7.79%
respectively, reflecting North American funds’
outperformance at the aggregate level.
Benchmark IRR Quartiles (vintages 2005-2011)
by region
33%
28%
23%
18%
IRR
The range of returns between the best and the worst
performing funds is the widest in Europe, with a high
of 31.86% and a low of -11.57%; Europe also has the
best performing as well as the worst performing funds.
The top performing funds in North America and Asia
generated IRRs of 29.17% and 23.69% respectively. At
the bottom end of the last quartile, North America
performs best with a return of -7.56%, as compared to
-10.79% in Asia and -11.57% in Europe.
13%
8%
3%
-2%
-7%
-12%
Europe
1st Quartile
While some European funds provided higher returns
than North American funds, investors would have had
to take significantly more risk to avail themselves of
11 The
North America
2nd Quartile
3rd Quartile
Asia
4th Quartile
Pooled Mean
MSCI North America SMID Cap Index covers small- and mid-cap representation of the US and Canada markets and is comprised of 2,497
constituents. It covers approximately 28% of the free float-adjusted market capitalisation in each country.
12 We do not include funds from younger vintages as they are still in their investment period, hence preliminary returns are likely to change
substantially.
8
PE News @ INSEAD
A roundup of the latest in
private equity at INSEAD,
from what is happening in
our classrooms to an update
on PE-related events and
activities.
9
News from the Classroom
TURNAROUND - now with Simulation
INSEAD’s popular elective on “Managing
Corporate Turnarounds” recently added a
weekend-long SIMULATION module. The
feedback from our 200 MBAs taking the class in
Singapore and Fontainebleau was unanimous: a
valuable experience to round up their year at
INSEAD.
After some fine-tuning, the Simulation is expected
to find its way into both our EMBA and executive
education programmes.
The simulation was developed by a faculty-alumni
team from INSEAD after gaining detailed insight
into the venerable SAAB Car brand during its
struggle with bankruptcy in 2010/11.
The situation at the start of the simulation is dire:
sales are drastically down with a projected cashflow shortfall of more than Euro 100 million for
Q1 2011. The students are challenged to show
that this company can be rescued by using
operational improvement levers to lower costs,
reduce cash outflow and negotiate with suppliers
& creditors. - The perfect capstone elective to
put their MBA skills to the test and prepare them
for their new jobs post-graduation.
Excellent experience
that drew on many of
our former courses and
forced us to apply it in
a crisis situation
I learned a tremendous
amount - and the
course is in the running
for my favorite and
most impactful course
during the MBA.
(… )So much so that I
am eager to go out
there and apply it
immediately
10
Of all the simulations
played during the
INSEAD MBA, the
Saab Simulation has by
far the best and most
comprehensive
interface
PE Events @ INSEAD
Upcoming PE Events
TBLI CONFERENCE ASIA 2015
13th Annual INSEAD PE Conference, Europe
Over 18 years, TBLI CONFERENCE, dedicated to
building a global community of ESG & Impact
Investors’, has convened 28 international events
across Europe, Asia and the US, providing learning
opportunities and mobilizing private capital for
sustainable investment. The TBLI CONFERENCE
ASIA 2015 is held in cooperation with INSEAD in
Singapore on 29-30 April. Learn more about the
current program here.
INSEADs Private Equity Club (IPEC) will again host
its annual conference in Fontainebleau. In its 13th
year it has grown into the largest private equity
event hosted by an academic institution in Europe.
This year’s conference under the headline of
“How to create value when faced with high
valuations” will be held on May 22nd, 2015 at
INSEAD, Fontainebleau campus. Learn more
about the current program here.
INSEAD Entrepreneurship Forum 2015 Entrepreneurial Networks, Fontainebleau
7th Annual SuperReturn Emerging Markets
2015, Amsterdam
The INSEAD Entrepreneurship Club (ICE) will host
the Entrepreneurship Forum 2015 in
Fontainebleau on 21 May, 2015. The forum
“Entrepreneurial Networks: The Network
Advantage of a Connected Enterprise” explores
how well-designed alliance networks create
competitive advantage - network advantage.
Learn more about the program here.
The world-renowned SuperReturn series has
been running for over a decade and its events
are now well established as global must attend
Private Equity and Venture Capital conferences.
GPEI regularly speaks and presents recent
research at their events, and will do so also on
the topic of Family Offices in Asia at the 7th
Annual Super Return Emerging Markets from the
29th June-2nd July in Amsterdam. Learn more
about the current program here.
Past PE Events
INSEAD’s 3rd Asian Family Office Day
EVCA - INSEAD Family Office Event at the
Investor’s Forum
On 22nd January ’15, INSEAD hosted its 3rd Asian
Family Office Day for participants from family
offices and large family businesses. The event
featured findings from the Centre’s recently
published paper on Asian family offices:“The
Institutionalization of Asian Family Offices” and
provided a platform for family offices to share
their approach to Direct Investing in the region.
More than 40 Single Family Offices participated
in a Single Family Office Day in Geneva on the
17th March ’15 co-hosted by EVCA and INSEAD
ahead of EVCA's Investor Forum.
EVCA and INSEAD will continue their successful
cooperation in 2016.
11
Research by
INSEAD’s PE Centre
INSEAD's PE Centre is
regularly engaged in
researching wide-ranging
topics across the private
equity industry in an attempt
to make information more
accessible
to
those
interested in the industry.
The next few pages contain
summaries of the latest
research papers and findings
from INSEAD.
12
INSEAD - Pictet Report on the
Institutionalisation of Asian Family Offices
5 family wealth consultants in locations as diverse
as China and Dubai. A majority of the single family
offices we interviewed were at an early stage of
institutionalisation, characterised by minimal
process-driven investment decision-making and
diversification. Reflecting the relatively new wealth
in Asia, many of these families continue to operate
the business that originally produced the family
fortune; others own legacy assets or significant
stakes in the listed equity of the original family
business.
In recent decades, Asia’s emergence has
reshaped the global economic landscape. Over
the same period, capital has streamed into the
region thanks to massive current account
surpluses and investment opportunities. With the
uptick in activity enriching nations and individual
alike, Asia has seen the formation of investment
structures to manage this new-found wealth.
One of these is the family office, an investment
vehicle used to manage the assets of wealthy
families. With the number of ultra-high net worth
individuals in Asia doubling over the past decade,
the number of family offices in the region has
almost quadrupled since 2008. While the majority
of this growth has taken place in Singapore and
Hong Kong, family offices are also on the increase
across the region from Dubai all the way to
Australia.
We found that there was a heavy dependence
on the original entrepreneur for both investment
and non-investment decision-making within the
region’s family offices. This underscored the tight
grip on family interests maintained by first
generation wealth creators as well as the
importance of implementing effective succession
planning. Family offices at more advanced stages
of institutionalisation have stronger governance
processes in place, often with non-family
members in key decision-making roles, which
tends to ensure more consistent decision-making.
In response to this trend, a GPEI project was
launched to explore the institutionalisation of the
Asian family office industry. The level of
institutionalisation is an important signal of family
offices’ anticipated investment performance. With
institutionalisation comes more consistent (but
not necessarily better) performance as a result
of more stringent assessment of investment
opportunities and the way those investments are
subsequently managed. This more exacting
approach should, in theory, reduce the volatility
of portfolio returns and ensure improved wealth
preservation.
When it comes to portfolio management, we
found that advanced-stage family offices and
wealth creators with a background in financial
services tend to employ less risky strategies.
While less institutionalised family offices often
make high allocations to equity investment - up
to 65 percent in one case - advanced-stage
family offices tend to have more balanced
portfolios, managed by professional investors
both internal and external.
To explore this relationship and assess progress
in the institutionalisation of the Asia family office
industry, we conducted in-depth interviews with
20 single family offices, 5 multi-family offices, and
For further details, see the report on our website.
13
ESG in Private Equity:
A Fast-Evolving Standard
we decided to produce a case study-focused
report: ESG in Private Equity: A Fast-Evolving
Standard. The bulk of the report features 3-page
snapshots highlighting the key aspects of each
GP’s approach to ESG. To make the 11 descriptions
as objective and comparable as possible, we
applied a framework under the following
headings: Background, Policy Development &
Execution, Pre & Post-investment processes,
Measurement & Valuation, and Lessons Learned.
The ability of private equity (PE) firms to manage
environmental, social and governance (ESG)
investment considerations in their portfolio
companies has received increased attention of
late. Private equity firms on the fundraising trail
are not the only GPs cognizant of this trend; costsaving potential, competitor activity and regulation
all contribute to the rising awareness of ESG
factors in investment committee decision-making.
The focus on ESG considerations has developed
in parallel to investors’ growing appreciation of
the impact that nonfinancial factors can have on
value creation, long-term company performance,
and the health of society at large.
In addition to each snapshot, additional findings
from our research include specific sections
highlighting challenges related to measuring the
financial impact of active ESG management and
how GPs’ approaches to managing ESG factors
differ in emerging vs. developed markets. Case
studies and specific examples make our findings
more tangible and show each GP’s approach in
action. We conclude the report with a description
of the steps firms can take to implement an
effective ESG framework.
To shed light on how the PE industry approaches
this topic today, a recent GPEI research project
explored how 11 prominent buyout and growth
equity firms think about and address ESG
considerations throughout their business. Over
a series of interviews, we documented the
frameworks employed by each firm and
specifically how they evaluated ESG factors
throughout the investment process.
GPEI and INSEAD are currently exploring a
second project related to ESG, and we look
forward to continued engagement with GPs and
LPs as the topic of Responsible Investing gains
momentum in the industry.
While common threads were found between their
respective approaches, no two frameworks were
identical: clearly the industry is still in search of
definitive best practice. Given the varied
approaches described by project participants,
14
Brazilian Private Equity:
A New Direction
Until recently, Brazil was an emerging markets
champion. A decade of improved macroeconomic
performance and stability in policymaking,
coupled with a loss of confidence in developed
markets following the global financial crisis, made
Brazil a hot investment prospect. This positive
environment sparked a sharp increase in private
equity fundraising, which peaked in 2011, and the
establishment of local offices by major global PE
firms such as KKR, Apax and HIG.
resulting from 2010/11 fundraising has heightened
competition for the limited investment
opportunities available.
Over the long term, the structure of Brazil’s
financial markets represents an additional
headwind for the PE industry. The lack of
developed private debt markets continues to be
a barrier to large leveraged buyouts: 90 percent
of the PE firms (general partners, or GPs) surveyed
in our report said that the average deal involves
leverage of no more than 25 percent.
Underdeveloped and volatile public equity
markets limit access to the IPO market, shifting
the emphasis to trade buyers and secondary PE
buyers’ investment appetite. In addition, a
historical lack of local limited partners (LPs) those who invest in PE firms –compared to other
emerging markets exposes PE firms in Brazil to
shifts in international investment flows.
Fast-forward four years and the picture looks
very different. The sluggish global economy and
a drop in demand for raw materials has weakened
Brazil and put downward pressure on the Real.
The US Federal Reserve’s tapering of bond
purchases has created uncertainty across
emerging markets as liquidity is withdrawn from
the global system. Moreover, improving economic
conditions in the US have reduced investor’s
willingness to tolerate the risk which higheryielding emerging market investments involve.
Add to this the Brazilian government’s intervention
in energy, electricity and the financial sector and
you have a recipe for diminished investor
confidence.
While recent struggles and long-term structural
impediments hamper the development of Brazil’s
PE industry, on the whole industry participants,
remain cautiously optimistic. The long-term trends
that attracted investors to Brazil - positive
demographics and a growing middle class remain in place, and GPs expect sectors related
to consumer spending and consumer services
to provide opportunities for investment. The
market outlook among LPs is more mixed, with
international LPs viewing Brazil’s prospects as
somewhat diminished compared to other recent
bright spots in their portfolios. Notwithstanding,
several Brazilian LPs have increased their
allocations to PE, which bodes well for domestic
support of the industry moving forward.
As explained in our report “Brazilian Private Equity:
A New Direction”, the market’s deterioration has
had a big knock-on effect on the private equity
(PE) industry. At its peak in 2011, fundraising in
Brazil reached a record $7.1 billion, but dropped
sharply in 2012 and 2013. Deploying PE capital
in the current environment has also been a
challenge, as deal activity in Brazil during 2013
reached its lowest since 2009 at $2.8 billion,
nearly 50% below its 2012 level. In addition, the
influx of international PE houses and dry powder
For further details, see the report on our website.
15
LPs and Zombie Funds
in Private Equity Investment
Following the global financial crisis and the
ensuing political and economic uncertainty, there
was a significant decline in the performance of
the private equity industry. The fundraising
environment tightened and many private equity
managers – particularly in the mid- and lower
mid-market – failed to raise follow-on funds. While
their struggles largely played out outside of the
public eye, they did not go unnoticed by the LP
community. In June 2013, Preqin estimated that
there were about 1,200 ‘zombie funds’ - PE funds
managed by sponsors unable to raise a followon fund – with some $116 billion under
management.
to mitigate the risk of investing in a zombie fund,
including restructuring LPA clauses at the outset
of a fund commitment to reduce the potential for
conflict, and backing GPs that manage multiple
funds. The steps ultimately taken when a GP fails
to raise a follow-on fund differ on a case-by-case
basis, and the relationship and degree of trust
between a GP and its LPs are key determinants
of the corrective measures taken.
The report further sets out steps that GPs
managing zombie funds can take to improve their
fundraising capability. According to our
interviewees, the most important thing a GP can
do is preserve the trust of investors by maintaining
professional conduct and transparency, rather
than seeking short-term, opportunistic gains.
They also need to focus on the remaining portfolio
companies in a zombie fund in order to maximize
performance. There was consensus that while
managing a zombie portfolio a GP must define
its positioning and strategy in the light of future
fundraising, and communicate this effectively to
LPs. Nonetheless, it was generally acknowledged
that for GPs with zombie funds the fundraising
process is challenging.
In response, GPEI undertook a project to analyse
the emergence of zombie funds in recent years
and how LPs and GPs can best manage the
issues surrounding them. Our subsequent report
draws on insights from interviews with LPs and
services providers, including lawyers and
placement agents.
Our interviews showed that the main issue
surrounding a zombie fund is the incentive for
GPs to extend the term of portfolio investments
beyond the optimal holding period in order to
maximise the economics, specifically the
management fees drawn on invested capital. To
protect their interests, LPs can implement a
number of short-term measures to address this
conflict, from restructuring fund management
fees and terms to the outright removal of the GP
from the investment portfolio. There are several
long-term structural solutions they can employ
Our research and interaction with the PE industry
enabled us to provide a comprehensive overview
of this little-studied but topical issue. The GPEI
report will be useful to both LPs and GPs facing
issues relating to zombie funds, and its findings
should help improve the efficiency of the capital
allocated to this asset class.
Access the full report on our website.
16
Private equity buyers v strategic buyers:
Why private equity firms compete effectively
against corporates in the buyout battlefield
By Hannah Langworth, Published in Real Deals on 12 February 2015
case. They find some statistical evidence to back
up this theory.
The tussle between buyout firms and corporate
acquirers has been an enduring theme since
private equity’s genesis. A recent working paper
co-authored by Jan Vild, legal director of French
healthcare corporation Sanofi, and Professor
Claudia Zeisberger of INSEAD takes a look at this
issue, and its findings should prove encouraging
for the asset class. […]
The paper ends by asking whether strategic buyers
could ever emulate the discipline, flexibility and
focus of private equity firms. Vild and Zeisberger
determine that, while some corporates make
successful acquisitions, taken as a class they
cannot match the private equity industry in these
respects at the moment.
Overall, private equity firms come out clearly on
top. One of their key advantages, Vild and
Zeisberger argue, is the fact that they have to
raise capital from investors. Although this might
initially appear to be a restriction on a firm’s dealmaking abilities, the authors reason that it imposes
helpful financial discipline, being, “a major incentive
for the PE firm to focus on what matters most for
the limited partners, i.e., achieving the required
IRR.” For Vild and Zeisberger, discipline is also the
unifying factor behind many of the other
advantages they think private equity buyers have
over strategic ones. These include more effective
due diligence processes, better approaches to
negotiations, and the good track record many
firms are able to present of successful post-closing
value creation.
However, Vild is keen to qualify the paper’s
conclusions somewhat. “The average buyer on
the private equity side will be a little better in terms
of generating value for investors than the average
buyer on the strategic buyer side, but you’re going
to have a substantial number of private equity
firms that are doing worse than many of the
strategic buyers,” he says, and adds that, “the
interplay between private equity and strategic
buyers changes over time.”
Vild points out that private equity firms are
increasingly focused on creating value for investors
through medium to long-term operational
improvements rather than through leverage, and
that this is one area, “where private equity has a
lot to learn from the strategic buyer side”. He also
believes that many strategic buyers are building
on their traditional strength of generating value
through synergies by using tax synergies, a route
generally not open to private equity buyers. […]
Vild and Zeisberger do not identify any areas of
the dealmaking process where they believe
strategic buyers are ahead, though they do
conclude that the two types of buyer are relatively
evenly matched when it comes to deal sourcing.
Deal financing is another area where the
competition is close. When it comes to valuation
of a target, and hence how financially attractive
an offer a buyer is able to make, a strategic investor
will typically look to create value through synergies,
while a private equity firm traditionally relies on
leverage to do so. For this reason, Vild and
Zeisberger suggest that private equity firms may
have an advantage with targets in industries where
companies tend to have a low debt to equity ratio
as their leverage will make more of an impact
here, while strategic buyers might do better with
companies in industries where the reverse is the
Vild adds that, while it’s an advantage chalked up
to them in his paper, private equity firms should
not assume their due diligence or financial analysis
processes are superior to those of a strategic
buyer, using his own employer as an example:
“Sanofi is sophisticated in terms of approaches to
[the acquisition] process – we do thorough due
diligence, and [use] very complex financial models.”
So while the paper is a pat on the back for the
private equity industry, it would be very unwise
for firms to assume they can write off their corporate
competitors just yet.
*This article has been slightly shortened to fit the layout of this report. For the full version see Real Deals or
GPEI’s website.
17
Insights from GPEI's
Model Portfolios
In this section, we track the
evolution of our two model
portfolios to provide insights
into portfolio construction,
portfolio management, and
the challenges associated
with a growing and maturing
portfolio.
18
Summary Observations
When we began work on the inaugural edition of the Private Equity Navigator in December 2013,
we put ourselves in the shoes of a large institutional investor – creating two hypothetical portfolios
containing real funds13 to be able to understand how LPs manage private equity portfolios and what
challenges they face in doing so.
Of our two portfolios, Portfolio 1 was largely representative of the overall global PE market (i.e. with
a focus on buyout funds and the US), while Portfolio 2 had more exposure to growth-capital focused
strategies and emerging markets (mostly Asia) as well as European funds. In addition we “juiced” our
original portfolios by only selecting funds from the top three quartiles, implicitly assuming selection
skill.14 (Some of the funds selected have since moved into the fourth quartile).
Key Insights
Our two portfolios look very different in terms of their strategic and geographical weighting, yet they
face similar challenges, as described below.
A ballooning portfolio: Both of our portfolios returned considerable amounts of capital in the first
three quarters after inception, which required us to make new commitments across both portfolios
(four and six respectively). After a quiet couple of quarters, we are likely to make new commitments
from both portfolios before Q2 2015, as the gross allocation to private equity has fallen below $1
billion as a result of capital returned in both portfolios. In the real world, having to constantly make
new commitments requires significant in-house resources for the LP, both for the allocation and the
management of an increasingly expanding manager portfolio.
Portfolio diversification: Maintaining the predetermined exposure levels for our portfolios in terms
of both investment strategy and geography is challenging. A major determinant of whether the same
allocations to geographies and strategies can be maintained over time is the availability of PE funds
that meet the relevant criteria.
J-Curves: As we ended 2014, the J-Curves for both our original portfolios15 assumed a distinct upward
shape as a result of more capital being distributed to investors than called. With relatively mature
portfolios of on average 4.9 years, we expect to see the J-curves continue this upward path.
Performance: The performance of both portfolios improved over the course of 2014. Our North
American buyout-focused Portfolio I saw its MIRR increase to 13.05% in 2014 from 12.68% a year
earlier. Portfolio 2, which has a relatively higher allocation to Europe and Asia and growth strategies,
also saw an improvement in performance, with an increase in MIRR from 11.31% in 2013 to 11.69% a
year later. This increase took place despite a marginal decline in performance across both portfolios
in the fourth quarter of 2014.
13 You can see a detailed summary of the current geographic and strategy spread our two portfolios in the Appendix, including the IRR, MIRR,
TVPI and NAV of all individual funds.
14 For a more detailed look at how the portfolio was created and is managed, and portfolio allocation strategies, please refer to the Private
Equity Navigator Methodology on GPEI’s website.
15 For the J curve analysis we only include the original 40 funds to avoid distortion.
19
J-Curves and Comparison
of Portfolio Returns
for the portfolio to $441.61 million, and an upward
change in direction for our accumulated cash
flow curve.
Below we illustrate the cash flows associated
with our two portfolios, reflecting drawdowns
(capital called), distributions and the resulting net
cash positions (J-Curve). Only the original 20
funds in each of the two portfolios are included.
In Q4 2014, the original funds in Portfolio 1 saw
capital calls of $20.85 million and distributions
amounting to $47.42 million, marking the first time
more capital was returned than called since Q4
2013. This led to a decrease in the net drawdown
Portfolio 2 saw a continuation in the upward
shape of the accumulated cash flow curve as a
result of more capital being distributed ($67.45
million) than called ($22.46 million) for the second
quarter running. The net drawdown for this
portfolio stands at $517.03 million.
Fig 12
Fig 13
Portfolio 1: Cash flows and J-curve
Our full portfolios (including funds from 20082013) are now on average three years old. The
value of Portfolio 1 stands at a Total Value to Paidin Capital [TVPI = Cumulative Distributions + Period
NAV16 divided by paid-in capital] of 1.34x (as
compared with 1.37x last quarter). This means
that the portfolio has created about 34% value,
or $294.58 million, over the investment cost. The
TVPI for Portfolio 2 is slightly lower, at 1.29x (as
compared with 1.28x in the previous quarter),
implying that 29% value or $244.39 million over
the investment cost of $838.06 million has been
created.
Portfolio 2: Cash flows and J-curve
the market portfolio of all funds of these vintages
in the database). Conversely, vintage 2011 funds
of Portfolio 2, outperform their counterparts in
both Portfolio 1 and the market portfolio.
The ‘Combined portfolio’ comprises funds from
our two portfolios for reference purposes, in order
to show the benefits (lower volatility) of
diversification.
Fig 14
IRR comparison as of Dec 2014 for funds of
vintages 2008-2011
The superior performance of Portfolio 1 is
confirmed when we apply the MIRR as a
comparison measure. The MIRR of Portfolio 1
stands at 13.05% and for Portfolio 2 at 11.69%.
When returns from only the more mature funds
(vintages 2008-2011) in our portfolios are
compared, funds of vintages 2008 to 2010 in
Portfolio 1 comfortably outperform both Portfolio
2 as well as ‘Pevara all funds’ (which represents
16
While distributions and capital calls are “real time”, NAVs trail by one quarter due to the lengthy internal valuation process at PE funds.
20
APPENDIX
Portfolio 1:
• Strategy: Buyouts 81.8%; Growth 3.1%; Venture 4.3%; Others (Distressed & Mezzanine) 10.9%
• Geography: North America 71.7%; Europe 21.7%; Asia 4.3%; Other Emerging Markets 2.3%
Portfolio 2:
• Strategy: Buyouts 64.2%; Growth 17.5%; Venture 6.7%; Others (Distressed & Mezzanine) 11.7%
• Geography: North America 41.7%; Europe 35%; Asia 18.3%; Other Emerging Markets 5%
21