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Private equity assets rise to $2.5trn in 2008

The $2.5trn AUM is spread across a range of fund strategies. (GETTY IMAGES)

By Yazad Darasha

Private equity assets under management (AUM) in 2008 increased to $2.5 trillion (Dh9.17trn) in spite of a challenging financial environment, data released yesterday by industry group Preqin revealed.

Stronger than expected fundraising during the year – with 776 direct funds raising a total of $562 billion – combined with a slowdown in distributions back to limited partners helped to increase the AUM globally. "Limited partner" is the industry term for an investor in a private equity or hedge fund.

Assets under management for the private equity industry are calculated as the equity value of existing companies in the portfolio plus commitments available to be called up (otherwise known as "dry powder").

However, with asset values plunging worldwide, private equity funds are expecting significant write-downs in many portfolio companies, the research said. "As a result, the values of limited partners' holdings will decline, as would each [fund's] AUM," Preqin said.

"Whilst there undoubtedly will be significant valuation write-downs in certain portfolio companies – especially among high-leveraged companies acquired at or near the market peak – there are also many older portfolio companies that may have been held on the books at lower than market values, so the aggregate net effect across LPs' portfolios may be less severe than anticipated," the report said.

The $2.5trn AUM is spread across a range of fund strategies, from early stage venture funds to the largest buyout funds, and everything in between. Buyout funds account for approximately $1.1trn of AUM, of which $630bn comprises the value of existing portfolio companies, and $470bn is dry powder. Venture funds comprise 15 per cent of the entire industry's AUM, with $380bn. Private equity real estate funds have just under $500bn of AUM, while all other fund types together account for a further $510bn of AUM.

The key driving force behind AUM growth has been the strong fund-raising market since 2003. From a previous peak of $228bn in 2000, the market declined to a low point of $115bn in 2003, before commencing its tremendous growth to $587bn in 2007.

The 2008 vintage was lower at $341bn (although final closes remained higher at $554bn). These figures include all private equity fund types (buyout, venture, mezzanine, distressed, PERE funds, infrastructure etc) but exclude fund of funds and secondary funds, to avoid double-counting.

"As a result of the tremendous growth in fund-raising over recent years, the total AUM of the global private equity industry has grown from approximately $960bn in 2003 to just under $2.5trn in 2008 – an increase of 159 per cent in five years," Preqin said.

The value of portfolio companies in private equity firms' portfolios grew from approximately $530bn in 2003 to $1,480bn in 2008, an increase of 179 per cent over the period.

Dry powder, meanwhile, has grown from $430bn to $1trn over the same period, an increase of 133 per cent. "As would be expected, most of the dry powder sits in the more recent fund vintages which have not yet been called up, while the portfolio companies are spread over a wider range of vintage years, with much of this sitting in relatively older funds," Preqin said.

Approximately 85 per cent of the industry's entire dry powder sits in funds from the 2006, 2007 and 2008 vintages, and it is these fund vintages that stand to benefit from future investments made in the current depressed markets.

"Calling the bottom of the market is impossible to do with any certainty. However, it is clear historically that fund vintages that have been investing during recession years have delivered the best returns, and there is every reason to believe that the 2006, 2007 and 2008 vintages will eventually deliver great returns," the report said.

Conversely, it is the 2005 and 2006 fund vintages where a high proportion of the aggregate value of portfolio companies sits ($595bn or 40 per cent of the total), and where many of the investments will have been made near the peak of the market.

It is in these vintages that the biggest problems can be expected to lie. Older fund vintages are likely to be much less severely affected.

There are, meanwhile, several indicators that the private equity industry will continue to grow in spite of a severe financial meltdown, Preqin said.

"Preqin's bottom-up analysis of fund returns shows that private equity consistently out-performs other asset classes, and our top-down analysis of the returns that public pension funds earn across their entire portfolio confirms that these key investors have earned better returns from private equity than from the rest of their portfolios.

"As a result, there has been a consistent trend for more new LPs to enter the asset class, and for existing investors to raise their target allocation percentages over time."

According to Preqin's surveys of LP investment intentions, this trend will continue, "even in these challenging times".

In spite of its global size of $2.5trn AUM, private equity is still small relative to listed markets and the universe of family- and entrepreneur-owned businesses. "There is much scope to increase private equity's ownership further, and $5trn of AUM is possible within a five to seven year period," the report said.

Optimisim Still Reigns

With investors apparently struggling to meet the call-up obligations of their existing portfolios, at first glance, the future appears to be bleak for fund managers seeking investors in 2009.
"However, after speaking with 50 LPs in December 2008, we have found that though some LPs will be unable to make fresh commitments to funds in the coming months, there are also significant numbers of LPs that are looking to make new investments," Preqin said.

It said that 56 per cent of investors "informed us that their investment plans in the asset class have remained unchanged despite the financial crisis, and just seven per cent will not be making any further commitments in the next 12 months.

"Understandably given current market conditions, we are seeing investors become increasingly cautious. As many as 14 per cent will make fewer investments in the coming months than they would have in previous years and many will be conducting more stringent due diligence than they have in the past," Preqin said.

However, despite reducing the amount of capital available for investment, these LPs do anticipate making further commitments in the coming months, it said.

"Other investors have informed us they believe that though the credit crunch has put an end to the massive buyouts seen in the past two years, the current financial crisis has also created good opportunities for investment."