Access to top PE funds a major issue, says Mercer

Despite challenging conditions in recent years, investing in high-quality, top-tier private equity managers with significant experience and investment discipline should provide investors with a high probability of generating strong returns, suggests Mercer IC in its first-quarter Private Equity newsletter. Private equity markets generated strong returns in 2005, dominated by the small-to-medium buyout market sector. Venture capital returns were buoyed by stronger IPO and M&A markets but continue to be plagued by the technology bust of 2000, which continues to be a drag on performance.

Encouraged by robust investment activity and the realisation of profits from investment ventures, the first three quarters of 2005 saw an upsurge in private equity fundraising compared to the same period in 2004. This wave of new capital arises as limited partners boost alternatives targets or institute new allocations to private equity, a trend of the last few years that accelerated in 2005 and appears to be continuing in 2006.

'As a result of increased demand for private equity and a lack of quality investment managers in the market, slots in top funds were hard to come by,' said Caroline Aboutar, a Chicago-based senior consultant with Mercer IC who specialises in private equity. 'There has been a power shift. We’re seeing fewer examples of limited partners achieving investor-friendly terms. By contrast, there are more examples of general partners compressing fundraising schedules and insisting on solid commitments before limited partners complete formal due diligence.'

Ms Aboutar added: 'It’s unclear how such investment behaviour, with less time spent on thorough due diligence, will play out in the private equity market. However, there is the potential for some limited partners to regret not being more disciplined. We foresee another private equity bubble, albeit not as significant as that of the late 1990s. Consequently, the effort to rapidly deploy as much capital as possible, coupled with pressure on deal valuations, may decrease return prospects.'

'Institutional investors should take care to make rational investment decisions, taking the time to conduct formal due diligence,' Ms Aboutar said.

The private equity market in Europe is similarly robust. 'Within non-US markets, European private equity managers within the buyout sector have raised large sums of assets and face similar issues to those in the US," according to Sanjay Mistry, a London-based senior consultant with Mercer IC specialising in private equity. 'With many changes taking place in the European private equity market, managers have lately attracted significant capital as many limited partner allocations are now equally split between the US and European buyout markets.'

Added Mr Mistry, 'Although the UK and Scandinavia markets are relatively familiar with private equity, other European markets are opening slowly to private equity investors, especially when one considers that European businesses operate at lower enterprise values.'

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