“Not only has private equity been highly resilient during the Covid crisis, but some players have thrived as they navigated the economic turbulence,” said Zorzetto. He also noted how many investment asset classes have benefited in the short term from very loose monetary policy and the prospect of longer-term fiscal boosts. This has allowed managers to focus on deal making rather than handling distress situations at portfolio companies level. “There has been a massive increase in the dry powder for private equity and debt funds as investor appetite has grown,” he said.
There has been a massive increase in the dry powder for private equity and debt funds as investor appetite has grown.
With this increase in demand comes greater competition for promising investment in projects, with certain sectors receiving particular attention. Zorzetto notes that the pandemic and other long-term trends have driven growth in financial technology (particularly electronic payments), technology in general, and with the biggest upswing being in healthcare. “Private equity players nowadays need to have substantial sub-sectorial expertise” and “there is a greater need to commit to a strong value creation plan,” he added. Without the ability to prove and to deliver value creation, it would hamper attracting investors.
As the sector grows and matures, Zorzetto sees two other macro trends that are helping investors to manage the time scale of their investments and thus enhance liquidity management. There has been a “huge development” of a secondary market in private equity and an increased appetite for enabling longer-term investing.
As regards the secondary market, this involves investors acquiring existing limited partner private equity interests from other limited partners. With an investment cycle of 4 to 5 years, it was traditionally difficult for investors to exit before the initially proscribed maturity period, remaining tied to the fund even if there was a change in their circumstances or the investment style of the fund manager.
Now the industry has woken up to this, he sees this trend as “a major development”. He noted that total assets under management in the secondary market was 87 billion Euros in 2020, with 2021 estimates expected to exceed 100 billion, representing a very substantial year-to-year increase
“This is becoming a tool to manage illiquid assets and provide liquidity,” he said. On the buyer side, this has enabled capital to be put to work quickly. It can also shorten traditional investment periods with higher internal rate of return even if coupled with potentially lower exit multiples.”
On the sell side, “GPs [general partners] are increasingly willing to accommodate the secondary market within their own portfolio,” said Zorzetto. Either by facilitating LP transfer or – in its complex way – to ease GP led restructuring where a selected high performer is kept in the books of a newly established vehicle. This enables monetising the investment of the LPs while remaining focused on value creation of a (typically) stand-alone single asset initiative, which benefits from fresh capital from new investors.
A less marked but still significant trend is related to the desire to facilitate longer-term investment in private equity funds. Traditionally, funds will make equity investments in businesses for around two to five years before exiting, but there have been increasing numbers of general partners who are motivated to remain invested and delay the exit if they foresee future growth beyond this period. From the general partner side, this reduces administration and fundraising costs, as they, in effect, create larger funds which will last for a longer period of time.
A less marked but still significant trend is related to the desire to facilitate longer-term investment in private equity funds.
Whilst ESG is a burgeoning trend, Zorzetto advises that investors and fund managers should embrace this new trend with their eyes open. “If you want to embed ESG criteria within your investment strategy, you need to be ready to be more patient in terms of how fast you can expect a return on capital, but more particularly conscious of where you want to play and how you would like to win,” he said. He is also concerned about the potential growth of investment bubbles around ESG projects if they receive more support than the project can bear.
Also regarding the move to comply with the sustainable finance disclosure regulation, “we are still relatively far away from achieving a consolidated approach as players are digesting first wave of regulations without necessarily having all the tools and data to report on their ESG journey” as to how funds are classified. “ESG needs to be integrated across the value chain: from due diligence to ownership of the asset to exit. This cannot be just a tick-the-box exercise at the very beginning, aligning with a few KPIs,” he said.