Back to School: LPs stick with mid-market buyouts amid valuation, market cycle concerns: survey

  • 55 pct say current PE market feels like top of cycle
  • Dry powder pileup threatens returns but alternatives to PE lacking
  • LPs seeking an advantage are drawn to industry funds

Middle-market buyouts in North America and Europe remain the most popular options among LPs, with interest in emerging markets and venture capital decreasing, a survey of institutional investment professionals by placement agent Probitas Partners says.

“People are really concerned that the market is at a peak,” said Probitas Managing Director Kelly DePonte. “They’re also concerned that purchase-price multiples are too high, but that hasn’t affected their appetite for middle-market buyouts.“

According to one respondent from a U.S. family office, VC has lost its luster amid excessive valuations, lagging deal flow and disappointing exits. And political/economic complications in emerging markets have some investors turning back to developed countries.

While the mature buyouts market is not without worrying signs for investors, “they’re not necessarily seeing a better place to put their money,” DePonte explained. So private equity distributions are being plowed right back into the asset class.

Global PE fundraising is on track to beat the 2008 record, driven by very large funds with strong LP relationships. In North America, which accounts for more than 65 percent of the capital raised this year, dry powder is approaching $900 billion. And such estimates don’t include co-investments or separate accounts. DePonte said a panelist at a recent conference told him the amount of money in the marketplace is probably understated by 25 to 50 percent.

Certain investors with large portfolios are trying to slow down and be more selective, but the obvious problem is timing: no one knows when the market will turn or what will be the trigger. If there is a downturn and recent investments lose value, investors will have to take advantage of lowered purchase prices to protect their returns.

“You need to keep on deploying money in the marketplace and have dry powder with the right managers,” DePonte said. “Getting out of the market entirely doesn’t do you any good.”

DePonte recalled that in 2006-07, LPs who felt that a market top had been reached decided to back distressed-debt funds. But when the crisis came and central banks flooded the system with money, that bet didn’t pay off. Those who remember this disappointment remain wary of loading up on “the one subset of private equity which should be counter-cyclical.”

One adaptation LPs have made to the low-return environment is increased interest in industry-focused funds, especially healthcare and technology. More than half of respondents find single-industry funds appealing, and 60 percent are attracted to buy-and-build funds staffed with operating professionals.

“Seven, eight years ago, interest was simply not as strong,” DePonte said, “but investors are trying to find areas where they can get superior returns with GPs that have a competitive advantage.” Industrials gained ground, with interest increasing to 29 percent from 16 percent last year, while energy remains relatively unappealing.

Action Item: Check out the survey here: