The highest level of dry powder, cash or near cash reserves, ever recorded is one of the biggest challenges facing private equity fund managers in 2016 says Altius Associates.
The firm’s annual review identifies eight challenges and asks how private equity fund managers deal with the highest level of dry powder ever recorded while still delivering returns commensurate with private equity risk. This, together with making sense of the unprecedented number and complexity of private equity investment strategies now available, represents the two most significant eight challenges identified by the firm.
Commenting on the outlook for the private equity market in 2016, Brad Young Co-CEO, Head of Investments at Altius, says: “We believe that the private market opportunity will remain robust in 2016 and we look forward to working with investors to build long-term value in their private market portfolios.”
In Europe, Altius explores the challenge of generating good returns in today’s environment, where deal volumes are back to the level last witnessed in 2007/8. With distributions significantly outweighing drawdowns in 2015 and access to top performing funds becoming increasing difficult for investors, Altius warns investors to avoid being tempted to invest in funds that are not top tier in order to reach their desired allocation. In Asia, the firm explores the growing bifurcation in fund raising, which is resulting in large amounts of capital placed with fewer proven winners, which are typically larger scale regional buyout and control-oriented funds. This trend has placed added pressure on the smaller end of the market, which, in Altius’ view, remains highly attractive and offers diversification and the potential for outsized returns.
Looking at private credit strategies, Altius considers what will happen to the sector when interest rates rise over 2016 and beyond. It explores the impact of rate rises on legacy portfolios, new issuances and the borrowing cost differential. While private credit will remain an important sub-asset class for investors, Altius believes that there could be a partial reallocation of capital away from the private credit illiquid space to more traditional fixed income strategies.
The firm’s report also examines the ongoing impact of regulation on the private equity industry, in particular the review by the European Securities and Markets Authority (ESMA) of the AIFMD marketing passport for non-EU entities. It also discusses the review carried out by the SEC into fees and expenses and the Fee Transparency Initiative conducted by the Institutional Limited Partners Association (ILPA). Altius believes these regulatory developments will result in cost implications, which may affect the small private equity managers lacking the resources to implement the changes.
Turning to commodities, Altius reviews how investors should respond to current pricing and how they may potentially generate outsized returns in the years ahead. It argues that the current situation, where prices of many commodities at or below the cost of much of the world’s production is unsustainable and believes that the end of the down cycle is near. As such, investors who are not exposed to the private energy and mining sectors may miss out on one of the most exciting and contrarian investment opportunities of the decade.
The report concludes with the secondaries market, with Altius asking whether 2016 will be a good time to be a buyer, seller or both. “In the firm’s view, the cases for buyers and sellers are equally compelling. Sellers are utilising the market’s abundant liquidity by seizing the opportunity to sell at attractive headline pricing while buyers continue to seek the traditional attributes of secondaries and are accessing the less efficient areas of the private equity market.”
