- Fundraising bottlenecks persist while investors face manager selection challenges
- Resilient assets and creative structures set to drive M&A in 2023
- Private markets' resilient performance and access to new pools of capital provide optimism
Panels and conversations at IPEM 2023 in Cannes were dominated by private equity sponsors’ and investors' need to overcome the tough fundraising and deal-making environment, with a noticeable change in dynamics as the industry works out how to address its current challenges.
Still, the conference’s theme of “Reality Check?” appeared to resonate more with some groups of attendees than others. Five advisers who spoke to Unquote expressed concern about challenges in the primary fundraising market, with the expectation that GPs (general partners) will take longer to reach their goals in 2023 and might have to revise their targets.
Sponsors, on the other hand, remained broadly optimistic about the prospects of their portfolios and fundraises, arguing that strong deal pipelines and support from existing LPs are likely to carry them through. This was optimism was particularly true of direct lending, with Blackstone’s head of Europe and APAC private credit head Paolo Eapen saying on a panel that 2022 was “one of our biggest deployment years to date”, with the firm expecting to see a “golden age” for vintages in the current climate.
The question of whether private equity portfolios will be marked down in upcoming Q4 valuations featured in many of the conversations Unquote had with conference attendees, as well as the conference’s panels.
Although many LP stakes portfolios are being priced down on the secondaries market with the expectation of a drop in valuations, sponsors who are fundraising will be reluctant to mark their own portfolios down. As noted by one mid-market GP who spoke to Unquote, private equity valuations never rose as high as their comparables on the public markets. With many privately owned businesses still performing well, there is little to suggest that they should fall as far, they argued.
Meanwhile, limited partners (LPs) dealing with the denominator effect and liquidity constraints will need to make hard decisions about portfolios in 2023. One private capital adviser told Unquote that the denominator effect and the impact of lower distributions will result in some LPs needing to cut down their relationships or be required to make smaller commitments to the next funds from managers to whom they are now overexposed. A second adviser added that some LPs’ commitments are already spoken for with just 50% of their re-ups allocated for 2023, creating another year of fundraising bottlenecks.
A third adviser told Unquote that it continues to be difficult to secure commitments from US investors in Europe, with many still assessing the risks in the region brought about by the war in Ukraine and concerns over energy security and inflation.
Pantheon’s Helen Steers noted in a panel that the market is likely to see more disparity in the returns of different managers in a crisis, issuing “a word or warning” about less established GPs who do not have the “scars on their back” from previous crises. This does not translate to only backing GPs with larger AUM, however, with Steers noting that Pantheon spends a lot of time in the small-cap and mid-market spaces. “We can’t expect a mid-market firm to have the resources of a large firm, but we do expect them to be highly experienced and well-targeted,” she said.
When it comes to manager selection, Steers and fellow panellist Tom Masthay, deputy CIO of the Texas Municipal Retirement Scheme (TMRS), agreed on the importance of due diligence, combining numbers with an emphasis on the people involved with the GP itself.
Flexibility is key
GPs will need to find creative ways to generate or increase distribution to paid-in (DPI) in the current market, supporting their relationships with LPs and their future fundraising plans.
“Deals that get done this year will be for the best assets,” noted Stéphane Etroy, head of private equity at Ares in a panel, adding that this will include the healthcare sector and businesses considered to be resilient. Flexibility will be key to deal-making this year, he said, with minority, majority and structured equity deals all potential options for the sponsor. Co-control deals can “put oil back in the tank” when it comes to demonstrating DPI via exits, he added.
However, not all market players will be in a position to act on this. One French GP told Unquote that they plan to cut their deployment in 2023 due to the tough dealmaking environment that emerged towards the end of Q3 2022, which led to a narrowing of their typical deal pipeline.
Although continuation fund buyers will become increasingly selective, this route nevertheless remains a good option for sponsors, provided that the right rationale on the company’s growth exists, one secondaries adviser told Unquote. Buyer selectivity will be heightened by the fact that a number of them will be hitting the road for their next funds in 2023, they added.
When it comes to new deals, co-investments continue to be an avenue through which sponsors can bring in more equity in a tough financing market, as well as a way to offer incentives to their LPs to commit to their funds.
LP-GP alignment will remain key in any situations where institutional investors are being asked to make asset-level decisions, particularly given that this is something that they typically expect their GPs to do, argued TMRS’s Masthay.
Private markets resilience
In spite of evident concern about the primary fundraising market, some bright spots and areas of resilience stood out. Private markets have performed well throughout recent financial crises, and current vintages are expected to generate strong returns.
Sustainability and impact investing emerged as a continuing theme across the panels and conversations at the conference. Two sponsors with global mandates highlighted the importance of sustainable technology and supply chains within their developing strategies in their conversations with Unquote, while one fund-of-funds manager told Unquote that they are seeking to increase their exposure to emerging managers in this space.
On the investor side, demand has evolved from seeking broad exposure to impact to targeting specific themes, another adviser said. Barriers to entry remain high for those seeking to enter the buyout space, however, meaning that the market could continue to see more established sponsors launching strategies in this space, they added.
Some market participants are also taking comfort from the fact that private wealth and retail investing remain underutilised pockets of capital for private markets. BlackRock Managing Director West Lockhart noted that the firm is seeing many clients seeking to increase their private markets allocations to around 10%. “You might say 10% is not a lot, but today, the average client in Europe has an allocation of between one and two percent, which is starting off from a low basis,” he said.
The presence at the conference of platforms including iCapital and Truffle Private Markets further indicates the opportunity that such businesses see in this field, as well as sponsors’ willingness to seek out alternative pools of capital to weather the storm.
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