Private Equity

"Nobody in my generation ever started out in private equity.  We got there by accident."

David Bonderman, Founder of private equity firm TPG Capital


I have, in my partner George Roberts, a person who is the most wonderful man in the world to me. He's like a brother to me. Creating with him, being side by side with him, in whatever we try to do, is a real pleasure to me."

Henry R. Kravis, co-founder of KKR


 Privos 2019 Private Equity and Venture Capital Overview

Family offices are active in global private equity either as GPs or as family office LP investors.  For your family office, it is important to understand the ecosystem of private equity when you think about your asset allocation model.  Consider the following statistics about the private equity industry:

1)  In 2018, the private equity industry had a record high of $3.06 trillion in assets under management as of Dec. 31, up 20% from a year earlier, data from Preqin show.  This marks the highest annual growth rate ever since Preqin started tracking this data in 2000.  Dry powder crossed the $1 trillion mark to $1.03 trillion as of Dec. 31, up 24% from the year before, according to Preqin.  

2) The private equity coffers of institutional investors in private equity are by no means dwindling, as LPs continue to boost their exposure to the private equity market. Preqin surveyed active private equity investors in June 2019, 74% of which are planning to commit more or the same amount of capital to the asset class over the next 12 months compared with the past year. Fund managers will need to get creative to put this capital to work, uncovering the deals to generate the level of returns needed to continue attracting LPs to the asset class.

3) Dry powder in the private equity industry has seen consistent growth, almost doubling in value in the past 10 years from $670bn at the end of 2009 to $1.28tn as of June 2019, Preqin estimates.. But, while this is indicative of a strong and stable industry, investors and fund managers alike are increasingly concerned that if this rate of growth continues there may soon be too much capital chasing too few deals.

4) The overhang of capital available for private equity deals may well pose risks to investors seeking to achieve the required returns on their investments. Private equity fund managers face a difficult challenge and must decide whether to start putting this capital to work despite the record-high valuations, or to hold out for more attractive deals. A recent Preqin survey reveals that over three-quarters (79%) of investors feel asset valuations pose a threat to return generation at present; in comparison, 59% cited competition for deals as a key challenge.

5) Continuing capital flows into the asset class will likely produce a boom in family office portfolio company exits, and the way in which these exits are executed will become increasingly sophisticated. Family office portfolio company exits to private buyers may also increase, further strengthening private market activity. It has been our experience that global family offices are not concerned with private equity portfolio performance at present: 93% of respondents told us their investments had either exceeded or met their expectations in the past year.

6) Of the $1.28tn available globally for investment in the private equity industry, buyout funds hold the lion’s share, with some $740bn waiting to find a home for investment. According to recent Preqin investor news, Europe-focused buyout vehicles are certainly dominating the headlines. Danske Private Equity announced it is looking to deploy around €200mn in small- and mid-cap buyout funds; AP-Fonden 2 plans to invest up to SEK 500mn in mid-, large- and mega-cap buyout vehicles and bridge funds; and German multi-family office Circle Eleven plans to target buyout, growth and turnaround vehicles in Europe. LPs are evidently planning for strong, high-quality deal flow in the buyout sector for the future.

7) In 2018, U.S. venture capital firms invested a record $131 billion in 8,948 transactions in 2018, a 58% increase in dollar terms but a 6% decrease in the number of deals, according to data released Thursday in the PitchBook-NVCA Venture Monitor. Last year marked the most capital ever invested by venture capital firms. The previous record was in 2000, the year the dot-com bubble burst, when U.S. venture capital firms invested $105 billion in companies. Almost half of the 2018 money, 47%, was invested in late-stage, megadeals valued at $100 million or more, which amounted to $61.1 billion in 198 transactions in 2018. This is a 148% increase in late-stage, megadeal value from the $24.6 billion invested in 104 megadeals in 2017. At the same time, U.S. venture capital firms had fewer exits: 864 in 2018, down from 885 the previous year. However, total exit value increased to $122 billion in 2018 from $92 billion in 2017, according to P&I.

8) The unrealized value of invested assets held by fund managers also grew by 18% over the course of 2017, to $2.04 trillion as of Dec. 31.  This comes as private equity fund managers distributed $466 billion to investors, representing the seventh consecutive year in which fund managers have returned more capital to investors than they have raised.

9) Managers collected a record $430 billion from investors in 2017. They distributed a record $516 billion in 2016.  The private equity industry has managed to post record growth even as it returns significant levels of capital back to investors. 2017 did not quite match the record levels of distributions seen in 2016, but nonetheless approached half a trillion dollars for the year.  Although the net flow of capital was low overall compared to recent years, this is because fund managers called up a record amount from investors," Preqin reported in July 2018.

10) Private equity fundraising in 2018 slowed down as the number of funds holding final closes in the first six months of the year was, at 230, much less than half of the 677 for all of 2017.  In fact, this year the total capital accounted for in those closes – $162 billion – was significantly less than the $284 billion raised in H1 2017, according to PEI.  But while final closes can be the best way to accurately document capital raised, they don’t take into account ongoing efforts. The likes of Carlyle Group, Ardian and Lexington Partners are all out at the moment trying to raise funds in the $10 billion-plus bracket. It is safe to assume all will have success.

11) During the summer of 2018, global private equity dealmaking continued sharp downwards slide to its worth monthly result in the past two years. Dealmaking activity drooped to 476 deals worth about $46bn in August according to data from Zephyr published by BvD, down on July’s already low $55.6bn. Deal volume was the lowest recorded in the last two years, and value hit its poorest result since February 2017’s $34bn according to the research, while year-on-year activity was down from 560 deals totalling $74bn in August 2017. The overall PE dealmaking total was kept afloat by 12 investments valued at $1bn of more, which together accounted for almost two-thirds of the month’s total value.

12) According to Altassets only two deals topped $5bn in August 2018 – Thomas H Lee Partners and CC Capital Partners announced the largest investment after teaming up to buy out Dun & Bradstreet for $6.9bn via acquisition vehicle Star Parent, and Canada Pension Plan Investment Board was part of a consortium including Transurban, AustralianSuper and Abu Dhabi Investment Authority’s Tawreed Investments that bought 51 per cent of Sydney Motorway for $6.75bn. THL Partners was one of three private equity backers to feature twice in the top 20 deals by value, having also backed the acquisition of Universal Hospital Services by Federal Street Acquisition for $1.74bn. CPPIB also completed an institutional buyout of Goodman China Logistics Holding for $1.75bn, while Carlyle was involved in the $2.5bn investment in NEP Broadcasting and plans to take a 20 per cent stake in Fortitude Holdings for $476m.

13) The largest funding round – either announced or completed – in August was also the fifth-largest of the month, as GrabTaxi Holdings raised $2bn from OppenheimerFunds, Ping An Capital, Mirae Asset Financial, Sino-Rock Investment Management, All-Stars Investment, Vulcan Capital Management, Lightspeed Management, Macquarie Group and Toyota Motor. The US was the main target country by value, Zephyr said, with about $18.2bn-worth of deals, compared to $14.3bn in July, though investment was stripped away year-on-year from $39.4bn. In terms of volume, however, the US’s 111 deals were overtaken by China’s 121 deals in August, indicating value growth was driven by high-value individual deals rather than prolific dealmaking, according to Altassets.

14) While PE investment in China, the US and the UK was the main driver behind volume in August, the year-on-year decline suppressed the month’s total and contributed to volume hitting a two-year low.

Privos Capital:  Our 2019 View of Private Equity

CalPERS is always the pension fund to watch in the private equity industry. As CalPERS goes, so goes the industry, as they say. Thus, family offices were closing watching in February 2019, when CalPERS CIO Yu Ben Meng laid out a case at the fund's investment committee meeting Tuesday detailing why the $354.7 billion pension plan needs to increase its private equity allocation, demonstrating that raising its private equity target to 16% could provide higher overall returns. Mr. Meng shared a chart with three theoretical portfolios showing that raising private equity to 16% target would increase the total fund's expected return to 7.3%, compared to 7% with the current 8% private equity target allocation and 6.7% with a zero private equity allocation. The three theoretical portfolios do not hold the allocations to most of the other asset classes constant. For example, global equities has a 50% target in the current portfolio, a 55% weighting in the zero private equity allocation portfolio and a 46% allocation in the 16% private equity target allocation example, according to P&I. Mr. Meng said that he was using the 16% allocation as an illustration. While not identifying his desired private equity target allocation, Mr. Meng said, "We would like to have as much as we can, as much as our liquidity profile can afford us." Private equity earned 12.5% for the one year, below its 13% benchmark; 11.3% for the five years, compared to its 13.2% benchmark; and 11.4% for the 10-years, underperforming its 14.5% benchmark.

Despite the foregoing, on the ground, private equity fundraising activity is still frenetic. As a multi-family office, we can report that it is commonplace for firms to speed up their return to market by counting ‘reserved’ or ‘committed’ capital alongside invested capital when judging whether they have reached their threshold to raise again.  For another indicator of robust fundraising sentiment, consider Blackstone. The firm’s fundraising plans – across all asset classes – are a good indicator of what mega-firms think is possible. Chairman Steve Schwarzman told investors late last week that the firm is ramping up its fundraising "supercycle."  If his choice of language has an epic ring to it, it’s because the amounts under consideration are epic: the firm is on track to raise $300 billion over the three-year period from 2017-19.  Blackstone has grown its assets under management 18 percent year-on-year to $439 billion, driven by inflows of $120 billion in the last 12 months: “an all-time record for both Blackstone and any other alternative investment fund”, Schwarzman said, noting that the ability of the firm to continue raising large-scale capital “begins and ends with investment performance”.  This buoyant market comes with a health warning.

As Warren Hibbert –  one of PEI’s Rainmaker 50 - has remarked, the split in the fundraising market is as stark as ever, with the mega-fund ‘haves’ pulling investors’ time, capital and relationships away from ‘have-nots’.  Last year was also another stellar year for private equity and the total AUM for the industry now stands at $2.49 trillion, an all-time high.  It is our view that private equity is well positioned for another strong year in 2019-2020, despite continuing economic concerns and wider political volatility.

Privos private equity outlook for 2019 is that family offices will continue to invest in private equity in increasing numbers this coming year, for in low interest rate environment the asset class will continue to appeal to investors looking for high absolute returns and portfolio diversification.  Preqin advises that a record number of private equity funds are currently in market: 1,829 funds are seeking an aggregate $620 billion. This will bring challenges, particularly for first time and emerging markets managers, in competing for investor capital as well as in meeting the demands of an increasingly sophisticated investor community.  However, with the majority of LPs sitting very liquid as a result of continuing distributions and looking to maintain, if not increase, their exposure to the asset class, fundraising has rarely looked so appealing. A significant proportion of assets invested prior to the Global Financial Crisis (GFC) are yet to be realized, so should market conditions remain favorable it is likely that the fervent exit activity will continue in 2019.  While pricing remains a very real concern, fund managers have record levels of capital available to them and our survey results indicate that many are looking to increase the amount of capital they deploy over the next 12 months.

For family offices active in private equity, we refer you to the thinking of our friend Tim Jenkinson, Professor of Finance and Director of the Private Equity Institute at Oxford University Said Business School:

The 'impact' of private equity is being felt in most businesses and, directly or indirectly, on vast numbers of individuals.  But very few people know how it really works.  What is the relationship between investors and funds?  How are deals structured?  What are the strategic issues in this fast-developing area?  How have things changed for private equity since the financial crisis?” 

Private equity a rebranding of leveraged buyout firms after the 1980s. The most common investment strategies in private equity include leveraged buyouts, venture capital, growth capital, distressed investments, and mezzanine capital.   Private equity has also been described as the risk capital that investment funds place in unlisted companies.  

According to the International Finance Corporation (IFC), a member of the World Bank Group, private equity investment in Emerging Markets stands at approximately $320 billion today of the $2.7 trillion global total.   As 90 percent of the developing world's jobs are created in the private sector, global family offices who own funds and portfolio companies help build dynamic job creating companies that drive economic growth.

At Privos, our family office partners invest in private equity to generate returns despite high competition for quality investments around the world.  However, many family offices find the current world of private equity confusing and tough to navigate due to aggressive investors, challenging exit markets, massive new regulation, and difficult questions concerning leverage and fee structures.

Generally, it is difficult for a family office to see clearly inside the “black box” of private equity and truly understand what is happening in the industry.  Certainly, family offices in today’s turbulent markets are using private equity as a transfer mechanism to transfer wealth between generation.  Yet, for a family office to become a truly successful private equity investor, it must become an expert in the drivers of private equity strategies, learn the skills needed for each type of investment, and figure out the best way select funds and assess performance. 

In 2019, private equity is a significant and accepted part of the global economy with a seat at the table of corporate governance.  It is the glue of ownership and control and can add tremendous value and impact to a family office portfolio companies. 

As a multi-family office, we are active in private equity, or thinking about making their first investment into a private equity GP,  to figure out a way first to understand the complexities of private equity investing and then to appreciate what the future of private equity is heading in the coming years.  Put simply, questions your family office LP should be asking before you commit to a private equity investment includes easy questions such as how is the fund and deal structured, who will be the key players in any deal, and when and how you should plan your exit.  Those are easy, basic questions.  The harder questions that you must dig for answer include if the fees you are paying are too high, where will the GP find the best investment opportunities, how long has the team been together, is the fund the “dreaded new manager fund,” has the fund manager hawked a piece of the GP to secure a seed investor, does the fund have Frontier or Emerging Market risk, how does the fund deal with currency risk, how do you think about exit premium, does the fund incorporate ESG factors, and is the fund a signatory to UNPRI (what is UNPRI anyway and why does it matter?), does the fund have in house marketers or are they relying on placement agents?   


Our global family office partners are seeing a significant number of leveraged buyout firms, or 23%, that are expected to go out of business in coming years, according to the latest survey of 120 global institutional investors conducted by London and New York-based secondary private-equity firm Coller Capital.  The poll confirms and bolsters past theories, following up on a study from Boston Consulting Group from this past December that predicted between 20% and 40% of the 100 largest PE firms could disappear in the coming years.  So, what is happened to these private equity funds, the so-called GPs?

Coller’s survey found that 28% of the world’s venture capital firms and their leveraged buyout peers won’t be able to raise new funds over the next seven years. As a result, these groups will be forced to stop investing since there won’t be capital available to finance new deals. Institutional fund managers have reported declining fund returns. For example, Coller’s survey noted that 37% of respondents reported average private-equity returns of just 16%.

To make matters worse, a substantial majority of institutional investors, 84%, declined to provide their existing fund managers with capital for new funds over the past year and 20% plan to reduce allocations to private equity in the next 12 months. North American-based investors comprised the highest percentage of refusals at 92%, while 82% of European institutions and 70% of Asia-Pacific investors made up the remainder.  The moves are an effort by limited partners, as investors in private-equity funds are also called, to rebalance their asset allocations.

Some have gone further. Harvard Management Co., for example, sold off some of its interests in funds to select buyers known as secondary market private-equity firms.  And, large buyout funds, those with capital of $7 billion and larger, experienced a 35% decline in their valuations, while middle-market funds valued up to $500 million only declined by 8%.

Global Family Offices Follow CALPERS Private Equity Strategy

Other institutional LPs are reducing GP head count aggressively, sending shock waves through their GP managers.  For example, according to a recent article by the Wall St. Journal:

The California Public Employees’ Retirement System, or Calpers, will tell its investment board on June 15 (2015) of its plans to reduce the number of direct relationships it has with private-equity, real-estate and other external funds to about 100 from 212, said Chief Investment Officer Ted Eliopoulos….The reduction in outside managers won’t fundamentally change Calpers’s investment strategy, or the percentage of assets managed in-house versus externally. The remaining 100 or so outside managers will simply get a bigger pool of funds varying from $350 million to more than $1 billion, Mr. Eliopoulos added. The goal, Mr. Eliopoulos said, is “to gain the best deal on costs and fees that we can.”

Calpers, the largest U.S. pension fund, is also formally soliciting a partner to help manage its $40 billion private equity portfolio, according to Bloomberg.  Calpers plans to commit $7 billion to $10 billion a year in new capital to private equity, according to the solicitation. That follows comments by the system’s chief investment officer, Ted Eliopoulos, that he expects returns to decline amid expensive valuations and large pools of capital competing for deals. A record $453 billion was raised globally for private equity in 2017 and “dry powder,” or money awaiting commitment, exceeded $1 trillion at the end of December, Preqin Ltd. said in a report Thursday.

In 2018, Calpers reported that the asset class with the highest return for the fiscal year was private equity, earning 13.8%, although it underperformed its 14.7% benchmark return. The next highest returning asset class was global equities at 11.7%, slightly underperforming its 11.8% benchmark. Calpers is in the midst of studying how it can use a collaborative approach to investing including making direct investments either alone or together with other asset owners in each of its asset classes. Projected lower costs is consistent with the collaborative model, Mr. Christopher Ailman, chief investment officer of Calpers explained.   In private equity, for example, CalSTRS has been looking to hire investment professionals with more transaction experience, said Margot Wirth, director of private equity, at the recent investment committee meeting. The private equity team has been "drifting toward" hiring more deal-focused professionals but that should accelerate as CalSTRS moves toward the collaborative model, she said.  Currently, 93% of CalSTRS' $18.2 billion private equity portfolio as of March 31 was invested with external managers, with the remaining 7% internally managed, Ms. Wirth said.  She said that it would "not be overly ambitious" to expect that 20% of the portfolio could be internally managed in co-investments in three years. As part of its fiscal year 2019 business plan, CalSTRS' private equity team expects to work to establish joint ventures with other like-minded and complementary investors as well as to consider investing in money managers "when strategic for the program."

As reported in Pension and Investments, Calpers' investment committee got a first look at a revised private equity investment policy statement in which it would establish a subasset interim target allocation of 2% and a long-term target of 4% of the private equity portfolio for what it is now calling a multistrategy subasset class. (Interim targets are allocations expect to be achieved in 12 months to 36 months.) Last fiscal year, CalSTRS transferred the strategy it had then called tactical opportunities to the private equity portfolio from its innovations portfolio, where the strategy had been incubated. The new subasset class currently consists of 1.2% of the private equity portfolio but staff believes that some existing investments might logically reside in this subasset class, according to a staff report to the investment committee.  In addition to adding the new allocation, CalSTRS would increase its interim target to buyouts by 3 percentage points to 69% within the private equity portfolio, while retaining a 69% long-term target to buyouts, and trim the interim allocation to debt-related strategies by 5 percentage points to 10%. CalSTRS' long-term target allocation to debt-related strategies is dropping to 11% from 15%. The interim and long-term targets will not change for venture capital (10% and 7%, respectively,) longer-term strategies (2% and 5%) and special situations (7% and 4%). 

The new private equity investment policy would reorganize its two main categories — traditional and opportunistic — by moving longer-term strategies (formerly "core private equity") and special mandates to opportunistic from traditional. The traditional category would then consist of buyouts, venture capital and debt-related investments. Opportunistic would consist of longer-term strategies, special mandates and the new multistrategy subasset class. The revised private equity investment policy would also allow staff to make co-investments alongside all of CalSTRS' general partners across asset classes, not only private equity general partners.  Staff is expected to bring the private equity investment policy statement back to the investment committee for adoption in September.   Mr. Ailman noted that longer-term strategies, which include investing in longer-dated funds that can last 20 years, is at the early stages with a lot of managers "stepping in" to the strategy. He added that private equity is undergoing "big changes." He mentioned that CalPERS is considering creating a separate entity to make direct private equity investments. 

US pension funds are looking at ESG and Impact:  Separately, Mr. Ailman said that he was starting a study of whether to keep investments in private prisons because they are posing an increased risk to CalSTRS' portfolio. The new risk factors are in respect to violations of human rights by private prisons that are now being used to house immigrants and children of immigrants who have separated from their parents. CalSTRS staff have already been speaking to company executives but this process increases resources to staff. CalSTRS has $120 million invested in three private prison companies: CoreCivic Inc., General Dynamics Corp. and GEO Group Inc.  Mr. Ailman noted the UC Regents has already divested from private prison investments. The UC's investment office oversees the Berkeley-based university system's $66.7 billion pension fund and $11.9 billion endowment.  A spokeswoman for UC said that university sold some $25 million worth of indirect holdings in private prison companies in 2015. "As part of a comprehensive evaluation process for investments, UC assessed that these holdings were not a good long-term investment," she said in an email.  

During public comment, a large number of CalSTRS' members asked the investment committee to divest from its private prison investments. Douglas Orr, a retired professor of economics and social sciences at City College of San Francisco, speaking on behalf of the American Federation of Teachers, suggested that CalSTRS collaborate with other asset owners to pressure private prison companies to discontinue its contracts to house immigrants and immigrant children with the federal government. California Federation of Teachers is also pressing the idea with CalSTRS and the $357.3 billion California Public Employees Retirement System, Sacramento, said Tristan Brown, legislative representative in the union's Sacramento office.  In other actions, CalSTRS' board on July 19 approved a compensation committee recommendation setting the incentive criteria for a new position of director of investment strategy and risk. The new director would implement and monitor the overall investment portfolio's strategy and risk profile. During the board meeting, Mr. Ailman also noted as CalSTRS develops its collaborative model, the new director would make connections with other asset owners.

International family office LPs are also seeking to reduce their investments in private equity because of a lack of return on their investments. BCG reports that some 74% of respondents are expecting distributions — capital culled mainly from initial public offerings of private-equity-owned companies or corporate sales — to deteriorate over the coming year. A mere 25% think conditions for exits via IPOs or M&A transactions will improve.

Default Rate on Capital Calls Increasing

In the meantime, limited partners may also prevent their buyout fund partners from executing transactions. In North America, for instance, investors forecast an average 13% default rate on capital calls over the next two years. By comparison, only 8% of European investors are expected to default and Asia-Pacific limited partners are projected to have a 7% default rate.  However, with the slow growth of China and the current price of oil on the world stage, we predict that defaults will increase.

Challenges in Attracting Capital:  Family Offices as the New Solution for Private Equity

In 2019, iin the current geo-political reality, small and mid-market private equity is finding it harder than ever to attract capital in these uncertain times.  The so-called "New Manager Funds" are facing severe head winds in raising first time fund money.  There are many reasons for this, according to a recent study by Grant Thorton.  One is that the number of private equity firms looking for capital continues to increase, thus creating more competition, as larger traditional institutional LPs pull back on relationships. As a result, GPs have been desperate to find alternative pools of capital and are relying less on traditional institutional LPs and more on family offices - both single family offices and multi-family offices - to fill the gap.   

Private equity is facing new challenges today around the world.  When HMC and Calpers reduce head count, GPs start to panic, especially those managers with less than $5B AUM.  Further, a private equity fund that has a 10 year lockup and two 1-year extensions will certainly face headwind resistance by family office LP investors who view a decade as a long time to keep their capital locked up, especially following the raw experience of the global financial crisis.  Further, most investors would prefer a more liquid structure; thus, there is a trend in the family office LP world to move away from blind pool investing.  Separately, institutional investors like banks and insurers are also withdrawing from fund investing.  

Ontario Teachers Goes Direct:  A RoadMap for Global Family Offices

Global family offices are following suit with the more sophisticated LPs looking to invest directly into deals and not into funds. Large single and multi-family offices are co-investing and doing direct deals with institutional money, even sovereign wealth funds which is a rather new trend.  For instance, an Asian sovereign wealth fund will now, in this new world order, partner with a leading European family office and do a direct deal into a E&P deal in Brazil in 90-120 days in some instances.  Scary but true for private equity GPs left on the sideline. 

For instance, Ontario Teachers (OTPP) invests in private equity funds where managers serve as general partners, but it also invests directly into portfolio companies. Ontario Teachers' Pension Plan first began to lead the Canadian pension funds' shift from sleepy, passive investors to globe-trotting deal makers 25 years ago. What Teachers started in 1991 with a few million dollars and its first direct private equity investment has grown into a multibillion-dollar private-capital group active around the world. Others have followed, with new funds specializing in buyouts and turnarounds emerging and more institutional investors seeking to boost their exposure to alternative investments.

The way it works today is that the OTPPs of the world - from Calpers to KIA to Singapore's state investment fund Temasek both co-underwrite deals with GP fund partners, but to the horror of private equity funds, OTPP and other LPs have big success with their direct investing programs, the need to partner with private equity disappears.  Global family offices are following OTPPs strategy of doing direct as well.  

For instance, recently OTPP co-sponsored one of its early deals with India’s Kedaara Capital.  The small deal gave OTPP a taste of the opportunity to be found in India; it also provides a window into how to mould new fund relationships as it pushes into emerging Asian markets, adding to its relationships with names like South Korea’s MKB Partners and Hong Kong-based Boyu Capital.  

At OTPP private equity is one the asset classes most likely to use external managers and the direct and co-investment program has helped reduce fees. In 2016 management fees for all asset classes were $358 million, down from $421 million in 2015 due to a reduction in external assets under management and related management and performance fees.  In 2010 about 60 per cent of the private equity portfolio was in funds versus 40 per cent directly into portfolio companies. Now this has shifted in favour of direct investing with around 30 per cent of the allocation in funds and the remainder directly into portfolio companies, the vast majority in developed markets. Until now.

And, with the bigger funds getting larger and larger, the landscape for a family office owned middle market private equity fund is getting trickier to navigate.   Thus, family offices GPs are looking at a wide range of creative solutions to the liquidity crisis in middle market private equity, including buying and running operating businesses as well as the frequent use of a special-purpose acquisition company (SPAC).  Family offices turn to Privos for creative help with these complex opportunities.  

In addition, family offices running private equity funds as GPs need to deliver high quality cash on cash multiples over a long duration.  A solid track record and experienced team can result in a family office GP fundraising success story.  As LP investors, family offices think about private equity in broad categories including large buyouts, small buyouts, venture and growth equity, credit / special situations, developed markets, and emerging markets.  Family office LPs are looking to invest with the right PE team for 20 years or more and are generally looking to bet on the right "jockey" and increasingly are becoming more and more agnostic as the "horse" or fund, as their deal team and IR professionals comes knocking.

Private Equity for Your Family Office Portfolio

As an investment, private equity plays an important role in a family office's long-term portfolio.  Following the financial crisis, family offices are re-examining their entire investment strategy.  Today, family offices are looking for a closer relationship of trust and loyalty between with their GPs; they no longer want to see delusional valuations of a GP's portfolio companies or deal fees that are not transparent.  The illiquidity premium for private equity has been driving family offices to negotiate fee structures more aggressively, not unlike pension funds and institutional LPs .  The trend today is for family offices to invest with real specialists - dedicated, sector-specific funds - with a long track records and world class teams.  Family offices investing in private equity and venture capital funds are also demanding more transparency, reporting, and understanding from their GPs.  They are no longer happy to sit back and let the returns roll in; rather, they are looking to invest with world class GPs who understand the unique, sticky, long term virtues that a family office LP adds to a fund.  And, family office LPs are demanding ESG and sustainability best practices from their GPs, not just lip service from the deal team.  Family offices won't engage with a GP that doesn't embrace the principles of UNPRI.

For our family office partners running private equity funds, the global regulatory environment is making it more difficult to operate their business. GPs are struggling with how to reduce marketing time to raise a new fund from two years to a fraction of that time, given the time and expense associated with raising your next fund.  Issues such as appropriate pay, regulations coming out of Brussels and Washington, Solvency II rules, Volker, FCPA, OFAC, managing advisers and gatekeepers, and a host of other complex issues pose increasing challenges for our family offices GPs who run private equity funds.  Conversely, institutional investors and other LP investors are demanding more specialist fund managers with a longer track record and credibility operationally and financially.  Pension funds, such as the Dutch and Canadians, have deep teams of operational people in house who challenge the assumptions made by the promoters and again demand ESG related investments across an entire portfolio.  In light of such stress, our family office partners work with our people to help their private equity funds succeed in these challenging times.

Private Equity Secondaries

Private equity secondaries firms attracted a record level of investor capital in Q1 2018, according to new data from Preqin, as six funds raised $14 billion - surpassing the sector’s previous all-time high of $13 billion reached in Q4 2018 and outpacing the $10 billion raised in the previous two quarters combined, as reported by Fin Alternatives.

Strong performance is driving investor satisfaction and commitments, Preqin noted in its first quarter Secondary Market Update. Median net IRRs for private capital secondaries funds exceed 15% in each vintage year from 2008, the company said, while among 2018 vintage secondaries vehicles, the median net IRR is 19%. In comparison, median net IRR among all private capital funds of the same vintage is 9%.  

Other highlights from Preqin’s Private Capital Secondaries Fundraising report:

  • The largest vehicle to reach a final close through Q1 was Strategic Partners Fund VII, which secured $7.5 billion of investor capital, while three more funds raised more than $1 billion in capital commitments.

  • There are currently 48 secondaries vehicles in market targeting a combined $34 billion. This marks an increase in the number of funds, but a decrease in the aggregate capital targeted compared to the end of 2016, when 44 funds sought $38 billion.

  • Secondaries funds currently in market are targeting more mature regions: 52% of funds will focus on North America, and a further 40% will focus on Europe.

  • Performance within the industry is robust: secondaries funds of each vintage year 2008-2014 are generating double-digit median net IRRs, and surpassing wider private capital returns in corresponding vintage years.

  • When asked what multiples they anticipated from investments made in 2016, the largest proportion (43%) of secondary buyers expected multiples between 1.3X and 1.5X, in line with the average for previous vintages.

Last year proved to be a landmark quarter for the secondaries industry,” said Patrick Adefuye, head of secondaries products for Preqin, in a statement. “Investors have committed a record level of capital to funds as the potential for accelerated cash flows and outperformance of traditional private capital vehicles [prove] to be driving factors behind the current market expansion. Heightened competition, more aggressive buyers and the increased use of leverage may provide notable challenges, as in the wider private capital universe, but managers remain confident that the future of the secondaries market is promising,” he added.