LPs brace for lower returns

Investors speaking at a recent conference in New York feared an overcrowded market and capital overhang will drag on returns.

A sense of doom and gloom pervaded an institutional investor forum in New York this week, with many participants lamenting poor performance and proliferation of fund managers would keep returns low.

One major point of concern expressed repeatedly during the forum was the capital overhang in the private equity market, estimated around $420 billion.

Private equity managers have raised about $1.1 trillion since 2005 and will have a tough time spending the money in a market that is estimated to be $90 billion to $100 billion, according to David Turner, head of private equity at Guardian Life Insurance Company of America.

Turner gave a presentation at the Argyle Investment Forum for Endowments, Foundations and Pension Funds about the state of the private equity market, reflecting on some of the negative sentiment floating around the room Tuesday. He dispelled the notion that great returns can be found in the lower to mid-market, arguing its dynamics had changed and valuations driven up in light of  mega-funds having moved down market for deals.

Managers at the lower end of the market “are at war right now”, fighting over the attractive deals, forcing auctions and increasing prices, he said.

He said the “half a dozen or so” managers he wants to commit money to have not come back to market with new funds. Like many other institutions, if he wants to meet the organisation’s target allocation to the asset class, Turner said he would have to choose the “next best option”.

“This will drive down returns,” Turner said.

Some positive views of the asset class came from Sheryl Schwartz, former head of alternatives at pension giant Teachers Insurance and Annuity Association – College Retirement Equities Fund (TIAA-CREF).

Schwartz acknowledged managers made some bad decisions in the past few years, taking on too much leverage and paying too much for assets, but she said she expects buyouts to still outperform public markets.

Managers that overpaid in the last cycle, “probably won’t raise funds again”, she said. “Buyouts are a core part of any portfolio, and if you partner with the right manager, you’ll outperform the public markets.”