A decade ago, when Investec carried out its first GP Trends survey, the asset class was just emerging from the fallout of Lehman’s collapse and beginning to revel in what would become one of the most buoyant buyers’ markets in memory.
Right now, the industry is once again experiencing tumultuous times with a stark divide between those respondents canvassed before the coronavirus outbreak and those that were surveyed after the world went into lockdown.
But while almost two-thirds of general partners (GPs) believe the severity of the current crisis will exceed that of the 2008 to 2010 event, and expect returns over the next few years to be bleak, private equity investors are, once more, preparing to snap up bargains. Nearly three-quarters of those surveyed after lockdown highlighted the industry’s ability to buy discounted assets.
The crises that framed the last decade of GP Trends surveys are, of course, themselves very different. The private equity industry has also evolved dramatically in the intervening years – shifts that the survey has captured. Here, we review some of the changes that have taken place and the industry’s expectations for the decade ahead.
A large proportion of the lending mid-market recently has been driven by credit funds and not, necessarily, by banks
The changing shape of the industry
One of the most significant evolutions, has been the development of multi-strategy platforms, says Jonathan Harvey, Head of Relationship Management in Investec’s Fund Solutions team. “The majority of firms have stuck to the brand being a small number of individuals – I don’t think we have solved the inherent problem of succession – but others have positioned themselves as successful fundraising and investment machines, building value in the brand itself.”
The lending environment for private equity firms has also changed beyond all recognition in the wake of the 2008 Global Financial Crisis.
A decade ago credit funds stepped in to fill the gap left by many banks withdrawing however, in light of the financial and economic struggle this year that may not be the case this time around.
“A large proportion of the lending mid-market recently has been driven by credit funds and not, necessarily, by banks,” says Callum Bell, Head of Growth and Leveraged Finance at Investec. “It is difficult to ascertain how credit funds will act in a distressed scenario. My sense is the banking market is more prepared for, and has the experience of, wholesale restructuring. Furthermore, the credit funds have typically played at the riskier end of the market, while the banks have been more conservative. Banks may also be more mindful of preserving long-term relationships versus funds who are, by definition, primarily focused on investor returns.”
Indeed, this year’s GP Trends survey is already pointing towards a move away from unitranche funding – down from 32% to 28% since the COVID-19 outbreak, in favour of syndicated lending, with 34% of GPs using syndicated loans to finance portfolio acquisitions, up from 21%.
I think there were regrets, from investors that pulled out of the market after the financial crisis. They saw how the secondaries players came in and made a lot of money at that time
The 2008 Global Financial Crisis decimated the fundraising market. Limited partners (LPs) that had just begun dipping their toes in private equity waters quickly withdrew, others reduced their private equity holdings selling into a distressed market.
The current situation is once again impacting the fundraising ambitions of those planning imminent launches. A third of GPs surveyed said they have, or expect to, suspend or postpone fundraising for their next fund.
Institutional investor participation in private equity has soared over the past ten years – and almost 50% of respondents expect the number of investors committing to the asset class to continue to grow. The level of communication and transparency between LPs and GPs has advanced dramatically. It appears unlikely that we will see a large reduction in allocations to private equity from LPs. Those investors who held their nerve last time have been rewarded by consistently outsized returns.
“I think there were regrets, from investors that pulled out of the market after the financial crisis. They saw how the secondaries players came in and made a lot of money at that time,” says Harvey. “I don’t think we will see the same thing happen this time around. Another significant evolution we have seen over the past ten years is the growth of the secondaries market itself. There is far more liquidity if people do want to sell out, assuming buyers and sellers can reach a price.”
The importance attributed to ESG factors has also grown over the past decade. Initially driven by limited partners, but now fully recognised as supporting value-creation strategies by GPs. Significantly, 87% of those canvassed before the current crisis and 84.1% of those canvassed after, expect there to be an increased focus on ethical and ESG concerns in ten years’ time.
The industry’s endeavours around diversity, however, have borne less fruit. Gender diversity, in particular, remains a big problem. While 86.7% of pre-lockdown respondents and 82.6% of post-lockdown respondents expect diversity to increase over the next decade. Perhaps more revealingly, an overwhelming 75% of female respondents below partner level believe they would be paid more for doing the same job if they were male.
“The findings around pay disparity between males and females in this year’s survey were stark,” says Emily Cvijan of Investec Private Bank. “The fact that so many women below partner level indicate they believe they would be paid more if they were a man, suggests a very big problem remains. It becomes a self-fulfilling prophecy when it comes to gender diversity going forward. Few women will want to work in an industry with that kind of track record. The banking sector has made greater strides to redress the balance, as their shareholders are putting more pressure on them than LPs are currently putting on private equity firms.”
The deployment of technology across the asset class inevitably represents another major change over the past ten years, as firms have gradually embraced digitisation across the fund life cycle. The current situation is only likely to accelerate the role that technology plays, with 93% of respondents predicting an increase in the use of technology solutions.
“Some of the tech changes being forced on the world at the moment are likely to become more permanent,” says Harvey. “Historically, diligence meetings have always taken place in person. That is clearly not going to change anytime soon. But it is also causing a pause for thought about the longer-term environmental and business cost of travel.”
Indeed, it is clear that the world in which we live and work will never be quite the same again. The private equity industry will have to continue to adapt in order to thrive.
“Investec has been a supportive and innovative partner to private equity firms over the past decade, a period in which the industry has changed beyond recognition. We will continue to support and innovate, over the decade to come,” says Jonathan Arrowsmith, Head of Private Equity Client Group at Investec, pointing to some of the value the bank can bring to Funds, Fund managers and their portfolio companies across their lifecycle.
“We are going to see a fundamental change in the way people operate and do business in the future and, right now, no-one can predict quite what that will look like,” Arrowsmith concludes. “But we are committed to helping private equity firms be resilient to whatever may come their way, and ensuring they are ideally positioned to take advantage of the opportunities that lie just around the corner.”