Living in a bubble

Despite the huge increase in private equity fundraising over the last year, demand still far outstrips supply. Speaking at the EVCA investors’ conference in Geneva, Wanching Ang, co-CEO of Allianz Capital Partners, highlighted the dramatic shift in power between the LPs and GPs.

“In order to get access to the best funds nowadays I have to beg and bribe,” she said. “Our job is becoming uncomfortably close to prostitution. I’m even thinking of hiring some blondes.”

Her comments were echoed by fellow panel member Serge Raicher of Pantheon Ventures, who said that 10 of the 11 buyout funds in which they had invested in 2005 had been oversubscribed. In years gone by, GPs mobbed the LPs at the annual EVCA investors’ bash. This year, all the talk revolved around how the roles had been reversed.

It is abundantly clear that GPs have the upper hand to such an extent that return expectations for newer investors are out of kilter with what they are actually likely to receive. It is also worth remembering that 75% of the private equity market has an historic IRR of less than 10%, and the vast majority of participants are significantly lower than that.

Historically, performance in the buyout business has been subject to major fluctuations. And, it would seem entirely counter-intuitive to suggest that returns being generated by the funds entering the market at the moment are likely to mature into a golden vintage. A booming M&A market and soaring debt levels have pushed up prices just as the regulators are beginning to shine a light into the darker corners of the industry.

It is also becoming clear that an elite bunch of firms with access to the best deal flow, management and debt conditions; with global political clout and ingrained corporate processes will continue to outperform the market. In reality, institutions are being attracted to the asset class by the promise of returns that are, in fact, only being generated by these select few invitation-only funds.

Clearly, not every institution can invest in an a top decile, or even top quartile fund, and it is the new wave of investors that will find themselves locked into a long-term dance with GPs who may end up having two left feet.

If Allianz, with all its bursting coffers and experience in the asset class, is considering hiring blondes to gain access to the best funds, heaven knows what smaller investors will be tempted to try. Only one thing is certain, the regulator is watching, and when the bubble bursts, the industry can expect a gleeful chorus of “I told you so”.