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High deal prices are keeping LPs up at night

  • Coller Barometer: greater LP concern about GPs vying for deals
  • Higher levels of shadow capital may worsen pricing
  • LP interest in PE still remains strong

With purchase-price multiples often cracking the double-digit EBITDA range, a higher percentage of limited partners characterize the investment climate as challenging for private equity as an asset class nowadays, according to a closely watched survey.

Eighty-eight percent of LPs said they’re concerned about heightened competition for assets in 2016, up from 71 percent in early 2013, according to Coller Capital’s semiannual Global Private Equity Barometer, released on June 10.

“Purchase pricing for buyout firms is part of the thought process in people’s minds right now,” said Luca Salvato, partner at Coller Capital.

In 2016, average purchase-price multiples for U.S. sponsors increased to 10.5x EBITDA as of March 23, up from 9.57x EBITDA at roughly the same time in 2015, according to S&P Capital IQ. Second-quarter figures will be coming out in the next few weeks. Anecdotally, industry participants have said the pricey environment has persisted through the first half of the year, according to recent interviews by Buyouts.

Billions in dry powder built up in funds, plus billions more for co-investments and direct investments, may exacerbate the problem. Two-third of LPs fear this huge pile of money may have a negative effect on the future performance of co-mingled buyout pools.

“Shadow capital within private equity, such as directs and co-investments, has increased the absolute share of dollars looking for deals,” Salvato said. “The increased competition could lead to a reduction in private equity fund returns.”

The survey revealed that 69 percent of LPs agreed that unpredictability is making investment decisions inherently harder, compared with only 31 percent that said investment decision are no more difficult than in the past.

Eighty-six percent of LPs are worried about the growth in size of private equity funds, up from 66 percent in early 2013.

As pension funds and others cull their portfolios and consolidate the number of managers they work with, 70 percent of private equity investors agree that LPs are becoming less loyal to individual GPs.

On the plus side, 88 percent of LPs plan to maintain or accelerate their pace of commitments over the next two years.

That LP largess may not extend to hedge funds, however. One quarter of LPs plan to trim their exposure to hedge funds. One third of LPs plan to increase their allocations to private equity, infrastructure and real estate.

LPs also interested in ESG investing

While the Coller Capital survey revealed greater interest in private equity funds despite jitters about the deal environment, a separate study showed they’re also ramping up their participation in environmental, social and corporate governance investing as well.

The term ESG has been used to sum up investors that want to use their money for positive social change. But that term is also giving way to another moniker: global impact investing.

Global Impact Investing Network’s sixth annual study drew responses from 158 respondents that collectively plan to commit $17.7 billion in impact investments in 2016.

The number of impact-investing deals in 2016 is expected to increase 55 percent to 11,722 from 7,551 last year. The largest sectors by asset allocation are housing, microfinance, energy and other financial services, according to the study.

Action Item: Read Global Impact Investing Network 2016 report here, http://bit.ly/2528VBA

Photo of Jeremy Coller courtesy of Coller Capital.