Charlie Jolly principal at Matrix talks to Francinia Protti-Alvarez about recent fundraising trends and implications for the future.

There has been talk of LPs looking to reduce their PE allocations following a tough investment year 2009. With this in mind what are your expectations for fundraising in 2010?

We have seen an improvement in market sentiment with LPs more outward looking, turning some of their attention to investment as opposed to portfolio valuation and restructuring which characterised 2009. In general, LPs are making fewer investments and are more cautious in allocating their capital, wielding a relatively new-found power to dictate the key terms of their investment. GPs that spent time building relationships with potential as well as incumbent investors in their funds will stand to benefit as LPs favour teams they have followed for several years over those they have met more recently.

The majority of newly formed ‘first-time’ teams will need to prove their investment thesis and team stability by initially funding transactions on a deal-by-deal basis before attempting to raise a formal fund. Funding direct deals in this way allows LPs to work alongside a GP before committing capital to a long-term fund structure and we have seen an increase in LPs investing in transactions directly.

Investment and divestment activity at the GP level is key to establishing market stability and will in turn stimulate the fundraising market. We anticipate that lower mid-market and mid-market funds will lead the recovery due to the more ready access to leverage for smaller transactions.

The secondaries market has come to the fore in the past 18-24 months and we have seen a number of dedicated funds in the market. What is your perception of this trend?

A significant amount of capital has been invested in the secondary market as LPs have looked to get exposure to companies at a perceived discount verses their GP commitments that have remained largely undrawn. The level of completed secondary transactions has not yet risen to satisfy LP demand due largely to the challenge of valuing a private equity portfolio in a deteriorating market.
 
As GPs increase investment activity, LPs will need to fund these capital calls and some will come under pressure to divest parts of their portfolios in the secondary market. This pressure, combined with significant interest from secondary funds and some stability in the performance of the underlying portfolio companies, should lead to an increase in completed transactions.

If we look at the fundraising cycle, the majority of funds are expected to come to market between 2011-2013. What do you see to be the main implications for GPs?

Many long-term investors in the asset class will increase their allocations and a number of unsuccessful investors, such as those that pursued an over-commitment strategy for example, are unlikely to commit capital to the same degree with some exiting the market altogether. GPs that have out-performed will continue to raise funds whereas those with disappointing returns will gradually be wound up over the next 3-5 years.

We also anticipate that mega-funds will be less attractive as investors look to allocate more capital to mid-market and country-specific strategies. Furthermore, sector-focussed funds in growing markets such as energy, for example, where the GP can demonstrate their expertise will become increasingly compelling.

How is European private equity perceived among LPs and what makes the Benelux region more attractive compared to other European markets?

Europe will remain an important and attractive market in which to invest in private equity. However, as the region regains economic stability, forecast growth rates in the more developed economies are low and funds in the EU will increasingly have to compete for capital against those in Asia and South America in particular, where the industry is less established but the constituent economies are growing faster.

Benelux is often the chosen location for multinational companies to establish a European headquarters due to both its geographic location and the multi-cultural and multi-lingual nature of its workforce. Although GDP in the region has returned to growth and is forecast to remain robust, it is worth noting that in 2008 when deal volumes were high, nearly half of the transactions completed in the Netherlands were carve-outs. We believe that corporate divestitures from stressed multinationals will provide significant opportunities for GPs in the region.