Alternative Assets

Drowning in Liquidity

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New money is flooding private equity funds amid a dearth of new investments. Source: Reuters

The main thing about private equity is that it’s private – as in invisible. Virtually unknown to the public, these private equity funds now control a big share of the German economy, with investments in some 5,000 firms employing nearly 1 million workers and racking up sales of €179 billion, according to the German Private Equity and Venture Capital Association (BVK).

Even the names are impenetrable – EQT, KKR, Cinven, BC Partners, CVC, and Ardian, for example. But they are there, and getting bigger all the time. Seeking higher yields in a low interest-rate environment, German pension funds and insurance companies are rushing to fill the coffers of these private equity funds, even as the funds are still trying to find good investments for the cash already on hand.

A recent survey by BVK of investors who together manage more than €1 trillion found that nine out of 10 listed yield opportunities and diversification as the reasons to invest. Apollo Global Management, for instance, has already pulled in $24.7 billion in fresh capital, a record for them. Altogether, financial data firm Preqin estimates, private equity funds still have more than $600 billion available to invest.

“High valuations have made it harder for private equity fund managers to find attractive portfolio companies at reasonable prices.”

Preqin, financial data services firm

This rather confident group of fund managers took the stage at a Handelsblatt-sponsored “European Private Equity” summit on Friday. That they would be welcomed to Germany at all is not a given and shows how times have changed. Only a decade ago, left-leaning German politician Franz Müntefering famously described the industry as “locusts.” In a country full of conservative savers, the moniker stuck. Yet in the aftermath of the financial crisis, Germans have increasingly joined the bandwagon as they search for places the offer yield to park their hard-earned savings.

And yet not all is rosy. There is a dearth of new investments for this flood of new cash. Moreover, private equity funds increasingly find themselves competing for fewer available firms against “strategic partners” – companies in the same industry seeking to merge operations or gain a new foothold geographically.

CeramTec, a leading German ceramics firm, is already owned by private equity firm Cinven, but has been put up for sale. South Korea’s LG Chem and Japan’s Kyocera are bidding for the firm as well a gaggle of private equity funds – CVC, Advent, BC Partners, Bain, CD&R, and the Partners Group.

The competition forces the funds to pony up ever higher sums, and this depresses the return on the investment for the fund’s investors. Net returns traditionally run between 15 and 20 percent, but Jochen Butz, managing partner at the asset management firm HQ Trust, expects returns to drop below 10 percent.

“The purchase price that financial investors have to put up for target companies has grown by one-fifth on average in Europe between 2012 and 2016, and 30 percent in the US,” German asset manager Feri estimates.

Their popularity has boosted total assets under their management to some $2.5 trillion, but investors are getting nervous. A recent survey of 540 globally active institutional investors by Preqin found that only 58 percent have a positive perception of private equity – down from 84 percent in December. “High valuations have made it harder for private equity fund managers to find attractive portfolio companies at reasonable prices,” Preqin said.

As returns go down, this alternative asset presents less of an alternative. “When the expected return doesn’t lie significantly above the stock market, then we advise against it,” Allianz Global Investors says. Nonetheless, more than a third of the investors surveyed by Preqin said they will commit more money to private equity in the coming 12 months than in the past 12 months.

Rising interest rates are one cloud on the horizon, since increasing yields on traditional assets may chase retail investors away from private equity. Also, infrastructure funds, private credit funds and raw materials are other asset classes siphoning money away from private equity.

Ultimately, investors must keep in mind that private equity has some disadvantages that traditional asset classes, such as equities, don’t have. “The higher return expectations face a certain degree of illiquidity,” says Armin Eiche, German director of Pictet Wealth Management. “This is also tied to certain disadvantages in transparency.” Private equity, at the end of the day, is private.

Robert Landgraf is deputy finance editor for Handelsblatt. Peter Köhler and Anke Rezmer cover private equity. To contact the authors: r.landgraf@vhb.de, p.koehler@vhb.de, and a.rezmer@vhb.de.

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