What is the way forward in European private markets?
Investor demand for private assets in Europe is set to keep rising, but so too is competition. What is the way forward?
Capitalize on Private Asset Growth
European managers of private equity and debt saw their assets under management (AUM) reach significant highs last year. In June 2019, private equity AUM stood at €717 billion (US$815 billion) and private debt reached €162 billion, according to Preqin. Fundraising momentum has passed its peak for private equity, but European private debt managers had a record-breaking year in 2019. Although the market environment remains favorable, managers are accumulating assets for the expected downturn.
The increasing size of private equity funds is leading GPs to increase either the number of deals per fund or the size of deals. This can lead GPs to exhibit diminishing deal selectivity and creates a risk of expertise drift. LPs need to monitor GPs’ deal teams relative to fund size. These concerns will be compounded by the growing dry powder and rising deal volume in the industry. Potential metrics can include the number of unrealized companies per investment team member and the growth in the investment team relative to that of the fund. Particularly, LPs should pay attention to managers that increase the size of successive funds at a faster rate than AUM for the asset class.
Cerulli expects the market environment to become more challenging for private equity managers, especially those that fail to deliver above-median returns. Although they have so far benefited from stable pricing power and favorable contract terms, we expect intensifying competition, a downturn in the business cycle, and greater focus on industry practices to increase the pressure on managers.
Intensifying competition and increasing dry powder in the industry mean that GPs need to diversify their deal-sourcing capabilities. For 58% of the managers surveyed by Cerulli, expanding the regions under consideration is the preferred way to expand deal flow and improve capital deployment. Additionally, managers should explore technology, especially machine learning, to source deals, improve due diligence, and support operational improvements for portfolio companies.
Source: Cerulli Associates, The Cerulli Report—European Alternative Investments 2020: Matching Different Demands