London, 6 December 2011 – bfinance, an independent, privately owned consulting firm providing specialist, customised and transparent financial services advice to companies and institutional investors globally, finds a mismatch between long term actual and expected returns for private equity strategies in a major global survey of institutional investors issued today. Institutions surveyed continue to see private equity as a critical source of return enhancement for their overall investment portfolio, however experiences varied from strategy to strategy. Responses from institutional investors highlight a significant difference between expected returns from private equity strategies and the reality of realised net of fees returns in their portfolio. Institutional investors have adjusted their expected returns downward across most investments strategies facing a significant amount of capital uninvested, high competition for transactions and extended holding periods driven by lack of financing and liquidity constraints. A notable exception is private debt strategies, whose past returns are the most closely aligned with future expectations and today often provide a better risk adjusted return than other private equity strategies.

Key findings from bfinance’s third annual private equity survey include:

• 93% of institutions set their private equity funds a performance target (net internal rate of return - ‘IRR’) of over 10% yet less than half generated an actual net IRR of more than 10%.

However expectations and experience varies greatly by investment strategy:

• In terms of individual strategies, institutions considered expected returns from private debt investments as the most closely aligned with actual returns.74% expected a net IRR of over 10% and nearly 70% achieved this.

 

• In contrast investors’ sentiment on venture capital shows the largest difference between expectations and past experience with 87% of all investors expecting over 10% net IRR and only 44% of such investors having achieved 10% or above net IRR from prior venture capital investments.

 

• Buyout investment strategies are still attractive, although investors have reduced their return expectations. 89% of all investors surveyed expect at least 10% net IRR from buyout investments. 73% of investors have achieved these returns or above in past.

 

• Special situations investments are highly attractive in moments of distress or volatility, with 97% of all investors expecting in excess of 10% net IRR from these strategies. However there is some significant risk in manager selection as demonstrated by 24% of the respondents having achieved less than 10% net IRR from these strategies.

 

• Absolute returns is seen as the most appropriate benchmark against which to assess private equity strategies. 73% of all investors surveyed benchmark their private equity fund investments using net IRR and cash multiples against similar fund manager groups by vintage and strategies. 56% of investors have furthermore specified that they consider private equity as an absolute return asset class. Only 7% of investors compare private equity returns to inflation plus indices, and only 51% of all investors compare private equity performance to public market performance plus a premium for illiquidity.

 

• 88% of investors identified ‘portfolio return enhancement’ as the first or second most important reason to invest in private equity. A similarly important rationale for investing in private equity is the ability to obtain returns from sources not accessible through public markets: 81% of all investors say this as the first or second reason for investing. In contrast, only 24% of investors saw ‘risk diversification’ as being amongst the first two reasons for allocating to private equity.

 

• Although 54% of investors have a dedicated program which gradually builds up their private equity investments, only 20% have a tailored investment program that dynamically adjusts new commitments to maintain the diversification target at the underlying company asset level. This latter figure rises to 35% if we consider the population of respondents with over $5bn in AUM.

 

• Brand recognition and quality of the investors’ base were identified as important criteria for institutions when selecting a private equity fund manager. Over 56% of all investors ranked brand recognition and 59% of investors ranked the quality of the investor base of a fund manager as one of the top 3 reasons for investing in a private equity manager.

 

• Only 46% of institutions pursued additional verification of private equity managers’ reporting, with 54% relying solely on the reporting provided by the fund managers. This trend was more noticeable amongst smaller institutions (AuM under USD 5 billion) with 67% relying solely on the reporting of their private equity managers to monitor their investments, compared to 40% for larger institutions.

 

• In order to manage the risk and oversee liquidity in their portfolios, a majority (56%) of investors focus on achieving diversification at fund level, through a blend of vintage years and manager strategies. However the approach is substantially different between larger and smaller investors, 45% of investors with over $5bn of AUM prefer to dynamically adjust new commitments or invest opportunistically to maintain diversification targets at company asset level. This compares to 71% of smaller investors who adopt the opposite strategy: holding a diversified pool fund of investments for maximum risk diversification.

 

• Only 7% of investors actively manage their portfolios by doing side deals with secondaries or co-investments outside the direct fund commitment.

 

• There is strong support for customised portfolio implementation, with 90% claiming this is a logical step for investors seeking to improve transparency, control and improved terms for their own investments. However, when asked directly, most investors feel as if they have sufficient expertise to invest directly: just 10% of smaller institutions and 30% of larger institutions noted the importance of advice and assistance from a third party in monitoring their investments.

 

Commenting on the survey’s findings, Emmanuel Léchère, Head of Market Intelligence Group at bfinance, said:

“Clearly private equity has a major role to play in enhancing overall returns but to align actual returns with future expectations, more institutional investors need to adopt a dynamic rather than an opportunistic approach to portfolio management that emphasises stringent management selection, monitoring and negotiation in order to maximise the potential of investments in this asset class.”

Lorenzo Rossi, Managing Director, Private Markets, bfinance added:

“This survey underscores the fact that investors should actively invest in private equity rather than simply allocating to it. Average returns in the asset class often do not justify the illiquidity and too often realized returns net of all fees fall short of expectations. Therefore Investors need to focus on selecting the right managers that can create superior absolute returns. Amongst these, investors should seek out those that are correctly aligned to extract value for investors rather than for themselves.”

-Ends-

Further information can be found by visiting www.bfinance.com or by contacting:

JPES Partners: +44 (0)20 7002 7822 This e-mail address is being protected from spambots. You need JavaScript enabled to view it

About the survey

bfinance’s Private Equity Survey encompasses responses from 41 institutional investors, 83% of whom are directors of investment or portfolio managers, with 61% of responses coming from pension funds and the rest from fund of funds, insurance companies, endowments and family offices. The majority of respondents are from companies in Europe and the UK (53%) and North America (27%).

About bfinance

bfinance is an independent, privately owned consulting firm providing specialist, customised and transparent financial services advice to companies and institutional investors globally. Focusing on a range of solutions from investment manager search, selection and portfolio implementation to banking relationship services including optimising cash management processes, we have advised over 400 of the world’s most sophisticated corporations and institutional investors in over 25 countries from our offices across Europe, North America and the Middle East

Established in 1999, bfinance has over 60 employees in offices in London, Paris, Munich, Milan, Netherlands, Dubai, Montreal and Toronto. bfinance UK Limited is authorised and regulated by the Financial Services Authority.

bfinance’s Investment Advisory Group

The Investment Advisory Group supports the world’s leading institutional investors with highly customised specialist advisory solutions including investment strategy design, investment manager search and selection, customised portfolio implementation, analytics and monitoring.

bfinance has advised institutional investors in over 25 countries, helping them make more than 450 commitments totalling over $100 billion across all asset classes.

Our client base represents total assets of over $1 trillion and includes corporate and public pension funds, insurance companies, sovereign wealth funds, endowments, and family offices.

Appendix – key survey results in detail

Return expectations

Experience of returns

Monitoring investments - institutions with AuM up to USD 5 billion

Monitoring investments - institutions with AuM above USD 5 billion