Sovereign funds completing more PE deals

April 2017 | DEALFRONT | PRIVATE EQUITY & VENTURE CAPITAL

Financier Worldwide Magazine

The private equity (PE) industry has performed well in recent years, and 2016 was no exception. Though last year was not as prolific as 2015, it remained strong. There are a record number of PE funds currently active in the market: 1865 seeking an aggregate $624bn. Further, total assets under management by the PE industry have grown sharply – by 4.2 percent from the end of December 2015 to a new record of $2.5 trillion as of June 2016, more than double the size of the industry at the end of 2006.

On the back of last year, 2017 looks likely to be another notable year for PE activity, in spite of the ongoing economic and geopolitical volatility which has threatened to derail deal making activity of late. Low interest rates mean PE should continue to appeal to investors.

However, the industry is also undergoing a number of notable shifts. One of the most prominent has been the rise of sovereign wealth funds (SWFs), which are now an influential force within PE.

In fact, a number of SWFs have begun to bypass external fund managers to complete their own PE deals, according to a new report from Preqin, ‘Special report: private equity fund manager outlook’. It notes that in 2016, SWFs completed 137 deals, worth $45.2bn. By comparison, in 2012 they participated in just 77 direct PE deals worth just $14.8bn.

According to Preqin, SWFs currently have around $6.5 trillion worth of assets, and account for 19 percent of capital committed to the PE industry.

Increasingly, SWFs, such as the Abu Dhabi Investment Authority (ADIA), Saudi Arabia’s Public Investment Fund (PIF) and Singapore’s GIC, are hiring specialists to seek out deals, which allows them to negotiate with PE firms from a position of strength or to go it alone and bypass PE altogether. Historically, PIF has been a largely inactive holding fund, however a sudden glut of dealmaking activity, as well as the central role that it has been given in Saudi Arabia’s reform plans have put it on course to become one of the world’s most powerful SWFs in the coming years.

The emergence of funds like ADIA and PIF are not only significant for their domestic markets, but for target companies as well. SWFs tend to invest over a much longer period of time than PE investors; the difference can often be decades as opposed to the three to five year period favoured by PE firms. SWFs’ preference for longer investment periods is driven by the need to work assets harder as returns shrink, and partly by a conviction that only through originating or structuring deals themselves will they be able to get what they want.

SWFs still rely on PE funds to find deals and commit capital on their behalf, but few PE funds are able take the amount of capital that SWFs want to commit. Preqin also suggests that there is also growing disenchantment with the industry’s traditional 2 percent management fee and 20 percent performance fee model. In its December 2016 survey, 39 percent of institutional investors cited fees as one of the key challenges facing the industry, up from 19 percent in 2015.

SWFs are also able to gain better control over their deals, particularly over pricing, by pursuing acquisitions directly.

Some SWFs are bypassing PE in other ways. The Russian Direct Investment Fund, for example, has partnered with other SWFs from jurisdictions including China, Kuwait, Qatar, France and Korea, in order to drive returns.

Even with rising competition from SWFs, the outlook for PE dealmaking and fundraising remains positive.

Richard Summerfield