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CHICAGO – Uneven portfolio company performance may be driving private equity fund managers’ modest expectations in 2016, according to the seventh annual PErspective Private Equity Study
by BDO USA, LLP
, one of the nation’s leading accounting and consulting organizations. Twenty-two percent of fund managers surveyed report that 16 to 20 percent of their portfolio companies are performing below forecast, while another 20 percent of respondents say more than 20 percent of their portfolio companies are underperforming. However, the majority of respondents say that 15 percent or less of their portfolio companies are missing the mark, and 17 percent say that none of their portfolio companies are underperforming, the highest proportion since 2011.
“2015 was a year of mixed blessings for private equity funds. Though the U.S. saw solid signs of economic recovery, not all industries felt relief,” says Lee Duran
, partner and leader of BDO’s Private Equity practice
. “Portfolio companies in struggling sectors—such as natural resources and certain retail segments—are still hurting, and PE firms may be less inclined to invest in those industries until they begin to demonstrate signs of sustainable recovery. However, we still expect to see robust investment in industries with a stronger market position or the ability to leverage new technologies to build new customer bases, cut costs and improve productivity.”
The outlook for portfolio companies is not universally gloomy, but the risk of bankruptcy has increased for a small proportion of respondents this year. Eight percent of fund managers say they are likely to declare bankruptcy for one or more portfolio companies in the coming year, up from 3 percent of respondents expressing similar sentiments last year. By way of comparison, 13 percent of fund managers report declaring bankruptcy for one or more portfolio companies in 2015, roughly consistent with the number who did so in 2014 (12 percent) and up from 8 percent in 2013.
When it comes to addressing underperforming portfolio companies, cost reduction programs and re-evaluating market strategies are leading tactics for fund managers, with 77 percent of respondents reporting that they have employed these approaches. Meanwhile, just 27 percent say they have engaged a turnaround professional.
Solid Fund Performance Helps Offset Shaky Portfolio Company Outcomes
Despite some difficulties in portfolio company performance, 67 percent of fund managers say that the value of their entire portfolio, including all funds, increased over the past year. For those respondents reporting an increase in portfolio value, three-quarters say they saw growth of 6 to 25 percent, up from 68 percent of fund managers reporting the same level of growth last year. Only 13 percent of fund managers say their overall portfolio depreciated in 2015; 69 percent of these respondents report losses of 25 percent or less. These results remain consistent with last year’s study.
Exit Assumptions Remain Largely Steady, but Some Notable Trends Emerge
Also consistent with prior years’ studies, a plurality (46 percent) of fund managers indicate that their exit assumptions remain unchanged from a year ago. However, the number of survey respondents saying they have increased their focus on sales to strategic buyers grew by 12 percent, and the proportion saying they have increased focus on long-term holds more than doubled, from 7 percent to 15 percent. It appears that smaller funds—those with less than $250 million in assets under management (AUM)—are most likely to pursue a long-term hold, with 23 percent reporting an average holding period of seven or more years. Nevertheless, holding periods across all AUM brackets align with the overall industry average of 5.5 years: More than half of respondents say their holding periods typically fall between four and six years.
Exit options also mirror last year’s survey results. Seventy percent of respondents say sale to a strategic buyer is likely to generate the greatest returns, and 56 percent say sale to a financial buyer ranks second. Eighty-one percent of fund managers cite gaps in buyer and seller pricing expectations as the leading challenge to exiting their investments, a modest increase from last year (73 percent). Financial information uncovered by a third-party due diligence provider, considered the top challenge in 2015 by the second largest proportion of respondents (17 percent), grew less worrisome this year, ranked as the top concern by only 8 percent of respondents.
Respondents continue to be lukewarm on the prospect of public offerings, with only 10 percent expecting IPOs to generate the greatest returns in the coming year.
Fundraising Remains Robust, Fueled by Family Offices
Among the 64 percent of survey respondents saying they are currently raising new funds from Limited Partners, 42 percent report receiving the majority of their financial commitments from family offices, followed by pension funds (24 percent) and international investors (21 percent). Fund managers with AUM of $251-$500 million, as well as those with AUM of more than $1 billion, show particularly strong interest in pension funds, with about half of the respondents from each bracket citing them as the primary source of financial commitments.
Overall, experience and results remain the most important criteria LPs assess when they evaluate potential General Partners. Fifty-eight percent of fund managers say LPs prioritize track record, and 27 percent rank the management team as the second most critical factor.
These findings are from the seventh annual BDO PErspective Private Equity Study
, which was conducted from October through December 2015 and examined the opinions of 147 senior executives at private equity firms throughout the U.S. and Western Europe.
Other major findings from the BDO PErspective Private Equity Study
The BDO PErspective Private Equity Study
- Regulatory concerns persist. Twenty-eight percent of respondents continue to cite Dodd-Frank as the most significant piece of regulation affecting their fund at the sponsor level, followed by the Affordable Care Act (23 percent). This year’s study, which for the first time also polled Western European fund managers, finds that another 18 percent are most concerned about the Alternative Investment Fund Managers Directive (AIFMD). With many European countries struggling to implement the regulation—and with the European Commission issuing warnings to those countries they perceive as dragging their feet—it appears that the AIFMD will remain top-of-mind overseas for the foreseeable future.
- Enhanced transparency in focus. When asked about which tactics they plan to leverage in response to increased SEC oversight, a majority (63 percent) of fund managers indicate that they plan to evaluate and improve their internal controls, and 42 percent say they will increase communications and disclosures to LPs. Thirty percent also cite monitoring agreements as an important component of their compliance plans in 2016.
is a national survey conducted by PitchBook,
an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry.
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