Spotting the right investment is tough

The long period of economic slowdown and tight credit from which the world is now emerging is creating new opportunity regionally and globally for private equity investors and fund managers, even as overall deal making and fundraising remains muted.

As the second quarter of the year opens, investors are busy forming new opinions regarding everything from the most promising areas for future investment to ideal portfolio structure. But identifying the right investments is harder than it once seemed.

With the International Monetary Fund forecasting growth for the Middle East in 2010 of 5.2 per cent – roughly double last year's pace of expansion and twice the level expected this year in more developed economies – regional private equity investment is poised to prosper. Going forward, the sectors most likely to benefit from the region's hydrocarbon wealth as well as its rapidly growing population, high per capita income and multi-billion dollar privatisation programmes, include food, retail, education, healthcare, logistics, water, power and public-private partnerships in transport infrastructure and petrochemicals.

But while the best private equity teams putting money into the Middle East this year are likely to achieve long-term double-digit annual returns that are considerably higher than those available in developed markets, distinguishing winners from losers requires greater due diligence than ever, both regionally and globally.

A long, slow shake-out is occurring in private equity as loans fall due, with many firms that over-relied on leverage gradually losing their equity in restructurings.

Many of these firms will fail to raise new funds and will ultimately close shop.

Regional and international investors attracted by broad growth capital opportunities, or by newly popular niche strategies such as natural resources, corporate turnaround and infrastructure, whether focused on the Middle East or elsewhere, will need to examine with great care the track records of private equity teams, distinguishing between those with strategic and operational skills and those with little more than a knack for financial engineering and quick flips.

Investor evaluation of private equity teams is becoming even more complicated as the best and brightest at firms with compromised track records strike out on their own with first-time funds.

Identifying the most promising of these newly independent managers requires a major research effort, or insider knowledge of the marketplace. But those that take the time to identify them, and to properly vet the broader universe of private equity fund managers in the Middle East and in other geographies, will be richly rewarded.

In addition to stronger economic growth, easier access to credit and rising asset values another positive sign for both the regional and global private equity market in the second quarter and beyond is an increasingly active secondary market, where investors can sell otherwise illiquid private equity stakes to others. Higher asset values and growing optimism concerning the economy are pushing up secondary prices, and making it easier for buyers and sellers to come to terms.

Increasingly, global investors are using the secondary market as a tool for active portfolio management, buying and selling funds at the same time.

Rising secondary market prices, and the growing number and variety of secondary market players is just one more example of new opportunity – and complexity - in the world of private equity.

Writer is chairman and founder of Triago, an independent private equity adviser and fund raiser


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