Home / Private equity growth soars but new challenges emerge

The private equity market has not only recovered from its doldrums of 2007-2008, it is expected to struggle to satisfy investor demand over the next decade. Two-thirds of LPs plan to increase their allocations, according to the latest survey by SEI Investment Company.

SEI, a big US-based fund manager, administrator and advisory group, surveyed 200 PE participants – both GPs (general partners or managers) and LPs (limited partners or investors). Its previous survey was in 2013 in a series of reports back to 2009.

The report, “The Future of Private Equity”, is very bullish on the sector as it becomes close to mainstream for both pension funds and individuals. However, a confluence of factors, such as fee pressure, demand for transparency, liquidity issues and a shortage of GP talent, are combining to present an array of new challenges for both GPs and LPs.

One interesting development is that the quality of GP management is considered less important than previously, while the importance of investment performance has become the dominant selection factor. This is possibly because of a strong trend to retailisation as GPs look to provide more liquid products. Highlights from the report include:

Growth opportunities

Industry assets are projected by survey participants to grow at a median annual rate of 5.8 per cent over the next decade.

GPs expect more fundraising opportunities among a wide range of institutional investors.

A total of 64 per cent of LPs plan to increase their allocation to private equity, marking a steady gain from only 26 per cent five years ago.

GPs predict wealthy individuals will generate considerable demand for private equity going forward, either directly or through family offices.

Four out of every 10 participants plan to buy or sell secondaries over the coming year.

One out of every five LPs now prefers co- investments over traditional closed-end funds.

Private debt is becoming a cornerstone of many private equity firms’ growth strategies.

Selection process

The emphasis placed on investment performance continues to grow, with LPs and consultants more likely to view it as 
a “very important” factor than any other selection criteria.

The reputation and credentials of fund managers still play important roles in the assessment process, but they are not as paramount as they used to be.

There are pronounced gaps between LPs and GPs on the importance of portfolio transparency, fees and reporting as it relates to selecting fund managers.

Consultants are more likely than LPs to emphasise risk management infrastructure, a separation of investment and operations, and the presence of an independent administrator when evaluating fund managers.

Operating Challenges

Compliance is one of the most pressing operational challenges. More than eight out of 10 GPs say compliance costs are climbing faster than other operating expenses.

GPs are facing greater scrutiny from LPs as well as regulators. Two out of three LPs say they are increasing the level of operational due diligence they perform when hiring a new manager.

Data management has also proven to be a vexing challenge for many firms. One out of three LPs now expect GPs to provide for data mapping into their portfolio monitoring systems.

Fee pressure and transparency demands from large institutional investors are pressuring the bottom line at many funds.

Business Models

A specialised business model is widely viewed as more competitive than a diversified approach, but consultants are more apt than GPs to tout the virtues of a diversified model.

Compared to other asset managers, private equity firms continue to perform many more functions in house. But outsourcing can enhance the ability of GPs to manage data, monitor complex investment strategies, handle customized portfolios and improve investor reporting.