GLOBAL - Allocation concerns dominate LPs

The results are not surprising, with much ink currently being spilt in the financial press in relation to the 'denominator effect'; a term used to describe the process by which the percentage of an LPs portfolio represented by fixed, illiquid assets rises as a result of a substantial drop in the value of the liquid assets. In addition, there is much talk in the market of LPs knowingly over-allocating to strong performing buyout funds in recent years, with expectations that divestments from exits would allow them to meet ongoing draw-downs. However, with the number of private equity exits plummeting this option is largely unavailable.

The problems appear to be affecting North American LPs worst, with 29% of those surveyed stating that they expect to be over their target allocation by the end of 2009 - significantly more than in Europe or the Asia-Pacific region. One of the knock-on effects of these issues has been an increase in the number of LPs declining to re-allocate to an existing GP, with almost 4 out of every 5 North American LPs confirming a refusal to re-up in the last 12 months. More than 60% of European LPs and 52% of Asia-Pacific LPs also responded that they had declined a re-allocation request over the same period.

Despite this, many LPs expressed confidence in the medium-term prospects for the asset class, with 43% expecting a return of 16% or more on their portfolio in the next three to five years. Therefore, most ostensibly remain committed to the asset class; only 3% plan to decrease their target allocation in the coming year, which is broadly in line with stated intentions in recent years.

There was a general consensus that the recent swathe of large-cap buyout funds will be hit hardest by the economic downturn, with 69% of LPs anticipating a median net return of less than 1.5x from the current crop of mega-buyout funds. Unsurprisingly, small buyouts were highlighted as being likely to outperform other buyouts. Around 41% of respondents a median multiple of at least 2x - compared to 26% and 5% for mid-market and large-cap buyouts respectively.

In terms of geographic preference, the majority of investors suggested that the best opportunties for investment would be in the Asia-Pacific region over the next 12 months. Indeed, LPs from across the globe indicated a desire to increase their exposure to this region in the next three years, with India and China selected as the most favoured investment destinations. Respondents also indicated a desire to increase exposure to the Middle East, with 48% of Asia-Pacific LPs, 32% of North American LPs and 21% of European investors planning to target some of their private equity investment at the region in the next three years.

The study captured the views of a representative sample of 107 private equity investors from all round the world. IE Consulting is a division of Incisive Media, which has been conducting private equity research for 20 years.

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