Market view: Where should you invest in private equity today?
High levels of private equity fund raising often foreshadow lower returns and vice-versa. Our proprietary Schroder Adveq Fund Raising Indicator quantifies this relationship and highlights a divided market at present. It suggests that investors would be wise to prioritise exits in the large buyout, late stage venture/growth and Chinese renminbidenominated strategies. For new investments, more favourable conditions exist in small/mid buyouts, early stage venture and in certain emerging markets.
Investors have flocked to private equity in recent years, attracted by a combination of impressive returns, low volatility and diversification potential. This culminated in 2017 being an exceptional year for fund raising, with the headline amount raised increasing by over 40% year on year, breaking the previous record. New records were also set across many individual categories (Figure 1).
Figure 1: Record-breaking private equity fund raising
* Combines Preqin and Zero2IPO fund raising data. Includes Chinese renminbi (RMB) funds and 50% of SoftBank Vision Fund (50% assumed to be invested in public markets) Source: Preqin, Pitchbook, Zero2IPO, Schroder Adveq, 2018
With public company valuations already at very high levels, especially in the US, this flood of private capital has left acquisition multiples stretched, at least in certain segments. EV/EBITDA multiples reached new all-time highs in both the US and European large buyout markets last year, stoking fears that the market was overheating. Investors are increasingly asking what this means for their existing private equity strategy and new investments.
A leading indicator for performance
Intuitively, it is easy to see that fund raising volumes and future performance may be related. Increased fund raising leads to increased dry powder, tougher competition for deals, higher prices being paid and lower subsequent returns. The reverse is also true with slack periods for fund raising foreshadowing an environment more conducive to performance. Clearly other factors matter too, not least the broader economic and financial market environment but, as Figure 2 shows, the relationship has been reasonably consistent over time.
Figure 2: Increased fund raising has led to lower returns
* Fund raising amount has been de-trended and inflation-adjusted. Source: Preqin, Schroder Adveq, 2018
As the popularity of private equity investing has risen, some parts of the market look increasingly overcapitalised. We look at where the best opportunities may lie.