Private Equity Institutional Investor Trends for 2014 Survey

Transcription

1 Private Equity Institutional Investor Trends for 1 Survey

2 Probitas Partners is a leading independent knowledge, innovation, and solutions provider to private markets clients. We serve both institutional investors who seek to place capital and select leading fund sponsors who seek to raise capital for private equity, real estate, infrastructure, credit, special situations, and hedge funds. These services are offered by a team of employee owners dedicated to leveraging the firm s vast knowledge and technical resources to provide the best results for all its clients. probity n. [from Latin probitas: good, proper, honest.] adherence to the highest principles, ideals and character. On an ongoing basis, Probitas Partners offers research and investment tools for the alternative investment market as aids to its institutional investor and general partner clients. Probitas Partners compiles data from various trade and other sources and then vets and enhances that data via its team s broad knowledge of the market.

3 Contents The Private Equity Fundraising Environment... Private Equity Institutional Investor Survey... Overview of Survey Findings... Profile of Respondents... Sectors and Geographies of Interest...8 U.S. Middle-Market Funds... Venture Capital...1 Niche Private Equity Sectors... Fund Structures and Key Terms... Investor Fears and Concerns... Our View of the Future... 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1

4 The Private Equity Fundraising Environment Fundraising in 1 is on pace to exceed 1 s total as the private equity markets return to normalcy in the wake of the Financial Crisis. Different trends from 1 underlie the top line numbers in Chart I. Mega buyout funds in the United States and Europe are raising large funds that are boosting overall commitments but most of these funds are targeting smaller funds than they did at the market peak. In Asia, a relative strong point during the Financial Crisis, fundraising has fallen significantly in 1 and 1 especially for RMB-denominated, China-focused funds that had been growing steadily since 6. The overhang of undrawn commitments that built up from vintage year 6 through 8 funds is now finally burning off, releasing pressure on limited partners allocations. Interest in secondary funds and distressed debt funds is moderating from last year. Chart I Global Commitments Private Equity Partnerships USD in billions Q YTD Source: Thomson Reuter Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

5 Private Equity Institutional Investor Survey Probitas Partners conducted its online survey to measure investor interest, opinions, and perspectives on investing in private equity in October 1. This survey is administered annually to gauge emerging trends and to compare investors changing views over a longer period of time. One hundred and thirtyseven responses were received from senior investment executives globally, representing such institutions as public and corporate pension plans, fund-offunds, family offices, endowments and foundations, and consultants and advisors. Overview of Survey Findings The following summarizes the top-line findings from the survey: Steady interest in private equity. The rebound from the Financial Crisis continues, and investors are likely to commit slightly more to private equity in 1 than 1. Though the appetite for new managers is increasing, a number of investors remain focused on triaging current fund manager relationships as the last group of managers yet to raise since the beginning of the Financial Crisis comes back to market. Continued focus on smaller buyout and growth capital funds. Investors remain focused on smaller- and middle-market buyout and growth capital funds in the United States and Europe to diversify portfolios and commit capital to strategies where managers can prove recurring added value. Many investors have already established core relationships in these sectors, so are not looking to add many new ones. Interest in emerging markets is declining. Investors are increasingly concerned with political risk in the emerging markets and are less convinced that the inherent high growth story necessarily leads to strong private equity gains. Credit Vehicles (distinct from mezzanine funds) are rising in interest. Credit-oriented strategies and vehicles have come into fashion, especially senior debt and opportunistic credit strategies in Europe and North America, as difficulties in the debt markets have continued to create opportunities. Energy focused funds remain a significant focus for investors, especially in North America. This is true in no small part due to outperformance the sector has delivered over the past couple of years compared with the broader private equity markets. Large investors increasingly focused on co-investments. Large investors with the team and capital resources necessary to develop co-investment programs are increasingly targeting co-investments in an effort to enhance overall and net returns; the largest investors are pursuing direct investments as well. 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey

6 Profile of Respondents There were 1 respondents to the survey; most respondents were from pension plans, funds-of-funds, insurance companies, and family offices (Chart II). Respondents were geographically diverse, with strong participation from North America, Europe, and Asia; within Asia there was a particularly strong response from Japan (Chart III). As Chart IV details, many investors are near the top of their allocations, though investors expressed more allocation flexibility this year than they had last year. Funds-of-funds are different allocations are not really relevant as their ability to invest is driven by their ability to raise fund vehicles or separate accounts. Chart II Respondents by Institution Type I represent a: 1% 9% % 1% % Public Pension Corporate Pension/ Private Pension Plan Endowment/Foundation 1% Fund-of-Funds Manager 6% 5% 11% % Family Office Sovereign Wealth Fund/ Government Entity Insurance Company Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Bank Consultant/Advisor Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

7 Chart III Respondents by Firm Headquarters My firm is headquartered in: % % Western Europe North America Asia/Middle East % 1% Australia Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Chart IV Current and Target Private Equity Allocations As far as our current private equity allocation, we are: Roughly at our target and are looking to maintain that level of exposure 1 9 Under our target allocation and actively committing to private equity to achieve that target Over our target and are looking to reduce exposure to meet that target Roughly at our target but considering increasing the target Over our target but seeking to increase the target Looking to reduce our target and exit the asset class A fund-of-funds or consultant to which the question does not apply Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 5

8 What drives investors to invest? Consistent with Probitas Partners past surveys, all other reasons are secondary to pursuing the best available managers and funds, though the focus on best managers has become increasingly important to investors since the Financial Crisis (Chart V). Proven, top quartile managers can be difficult to access, and since funds only come to market every three to five years, many investors feel compelled to commit to these managers when they are available and open. Family offices are much more likely to focus on private equity sectors they believe will outperform, with % of those respondents following that strategy. More respondents are looking to increase commitments as 1 approaches, continuing the allocation rebound after the bottom of the fundraising market in 9 (Chart VI). Chart VII shows that two-thirds of respondents are focused on their current general partner relationships, with only 8% strongly focused on developing new general partner relationships. Based on our discussions with investors, many continue the process of triaging general partner relationships that they began following the Financial Crisis. Only % of respondents targeted separate accounts as their primary means of investing in private equity, the same number as last year. Chart V Drivers of Sector Investment Our sector investment focus in 1 is being driven by: My institution simply pursues the best funds and managers available in the market A focus on those private equity sectors I believe will outperform others in this vintage year 1 Maintaining established relationships with fund managers returning to market this year 9 Targeting funds that will provide access to co-investments My institution s need to diversify its private equity portfolio My need to decrease exposure to private equity My need to deploy significant amounts of capital allocated to private equity 1 The strategies that my clients have directed us to pursue 1 5 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 5 Private Equity Institutional Investor Trends for 1 Survey 6 1 Probitas Partners

9 Chart VI Private Equity Allocations For 1, we or the clients we advise are looking to commit across all areas of private equity (in USD): <$5 MM $5 MM $15 MM $15 MM $5 MM $5 MM $5 MM $5 MM $1 B >$1 B 1 1 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Chart VII Manager Relationships During 1, we would expect our primary focus to be: Evaluating re-ups with current general partner relationships with a limited look at new relationships 5 5 Evaluating re-ups with current general partner relationships, looking to decrease the number of relationships significantly Evaluating re-ups with current general partner relationships Actively pursuing relationships with new managers 8 8 Pursuing separate accounts with a smaller number of managers Our 1 commitments have already been completely allocated Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey

10 Sectors and Geographies of Interest Chart VIII details the sectors of interest to investors for 1: As has been the case in most of our previous surveys, middle-market buyouts and growth capital in the United States and Europe dominate interest. Interest in Asian country-focused funds declined from % last year to 19% this year because of continuing concerns about China. Chart VIII Private Equity Sectors of Interest During 1, my firm or my clients plan to focus most of our attention on investing in the following sectors (choose no more than five): U.S. Middle-Market Buyouts ($5 million to $.5 billion) 6 European Middle-Market Buyouts Country-Focused U.S. Small-Market Buyouts (>$5 million) 1 Growth Capital Funds Energy Funds European Middle-Market Buyouts Pan-European U.S. Large Buyouts ($.5 billion to $5 billion) Credit Strategies Secondary Funds Distressed Debt Funds Asian Country-Focused Funds Infrastructure Funds Mezzanine Funds Pan-Asian Funds U.S. Venture Capital Restructuring Funds 1 Fund-of-Funds Emerging Markets (ex-asia) 9 9 Mega Buyout Funds (>$5 billion or equivalent) 8 Cleantech/Green-Focused Funds Mining Funds European/Israeli Venture Capital Agriculture Funds Timber Funds Niche Sectors Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 8 1 Probitas Partners

11 At the margin, there is slightly increased interest in hard asset strategies, but the interest is scattered amongst infrastructure, agriculture, mining and timber funds strategies that may or may not be part of private equity allocations for respondents. Mega buyout funds continued to rank very low in interest, continuing the results of our prior surveys, even at the peak of the market. While investors continue to express a lack of interest, these funds continue to attract substantial capital in the market. Table I compares the top-ranked areas of interest from our survey (the survey before the Financial Crisis) and the current survey. The findings are not surprising: U.S. and European middle-market buyout funds scored extremely well before and after the Financial Crisis. Interest in U.S. Venture Capital has fallen significantly from, with only 15% of respondents targeting it in 1, ranking only 15th among all strategies. Even at the early stages of the Financial Crisis, interest in distressed debt was high as investors looked to hedge their bets in a frothy environment. Interest in distressed debt has moderated since then as the expected 1-year flood of distressed opportunities in corporate debt failed to materialize. Energy-focused funds soared into the top five in 1 on the back of strong interest from North American respondents, with % of them targeting the sector. Table I Investors Focus of Attention Among Private Equity Sectors Top Five Responses: 1 Sector % Targeting Sector % Targeting U.S. Middle-Market Buyouts 9% U.S. Middle-Market Buyouts 6% European Middle-Market Buyouts % European Middle-Market Buyouts % U.S. Venture Capital % U.S. Small-Market Buyouts 1% Distressed Debt % Growth Capital % Asian Funds 5% Energy Funds 5% Source: Probitas Partners Survey of Institutional Limited Partners, & 1 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 9

12 U.S. middle-market buyouts top ranking in the survey reflects the fact that % of the respondents are from North America. This trend is driven by the fact that most investors prefer local funds and strategies when building core portfolios, and then extend their portfolios geographically as they gain knowledge and experience, and seek greater diversification. Charts IX and X, respectively, provide a look at the private equity world through the eyes of European and Asian/Australian respondents. Not surprisingly, Chart IX shows European country-focused middle-market buyouts as the top ranked interest for European investors while middle-market Pan-European funds also scored well. U.S. middle-market buyouts were also of interest to Europeans, while infrastructure and credit strategies also scored well. Chart IX Private Equity Sectors of Interest; European Respondents European Middle-Market Buyouts Country-Focused 8 U.S. Middle-Market Buyouts ($5 million to $.5 billion) 6 U.S. Small-Market Buyouts (<$5 million) Growth Capital Funds European Middle-Market Buyouts Pan-European Infrastructure Funds 1 Credit Strategies U.S. Large Buyouts ($.5 billion to $5 billion) Asian Country-Focused Funds Restructuring Funds Distressed Debt Funds Energy Funds Mezzanine Funds Pan-Asian Funds Emerging Markets (ex-asia) Secondary Funds Fund-of-Funds U.S. Venture Capital Mega Buyout Funds (>$5 billion or equivalent) Cleantech/Green-Focused Funds European/Israeli Venture Capital Mining Funds Agriculture Funds Timber Funds Niche Sectors Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 1 1 Probitas Partners

13 U.S. venture capital was of little interest though it did outscore European venture capital. As shown in Chart X, Asian investors look at their home markets more favorably, though U.S. middle-market buyouts are still the major sector of choice. European country-focused funds and U.S. venture capital are of significantly less interest to Asian investors; they are much more interested in infrastructure and secondary funds. Asian respondents were also much more focused on traditional private equity strategies with little interest in alternative sectors like emerging markets outside of Asia, timber, and agriculture. Chart X Private Equity Sectors of Interest; Asian Respondents U.S. Middle-Market Buyouts ($5 million to $.5 billion) 5 Asian Country-Focused Funds Pan-Asian Funds 5 5 European Middle-Market Buyouts Pan-European 1 Infrastructure Funds Secondary Funds U.S. Large-Buyouts ($.5 billion to $5 billion) Mezzanine Funds Energy Funds Growth Capital Funds U.S. Small-Market Buyouts (<$5 million) European Middle-Market Buyouts - Country-Focused Credit Strategies Mega Buyout Funds (>$5 billion or equivalent) Restructuring Funds Fund-of-Funds Distressed Debt Funds 1 Cleantech/Green-Focused Funds U.S. Venture Capital Mining Funds Timber Funds Emerging Markets (ex-asia) European/Israeli Venture Capital Agriculture Funds Niche Sectors Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 11

14 As far as general geographic interest, the three major geographies of North America, Western Europe, and Asia continue to dominate investor interest (Chart XI). Notably, there was less interest in Asia reflected in this year s survey, with respondents targeting Asia falling from 65% from two years ago to 9% this year. Interest in emerging markets globally, as well as the individual regions outside of Asia, has also declined over the past year. Chart XI Private Equity Geographical Focus During 1, I anticipate that the three major geographical focuses for our program will be: North America Western Europe Asia Emerging Markets Globally Latin America Central and Eastern Europe Africa MENA Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 1 1 Probitas Partners

15 As far as European markets, for the seventh consecutive year, institutional investors preferred to invest in the Nordic Region by a significant margin (Chart XII). Germany and the United Kingdom, once again rounded out the top three geographies of interest, though interest in the U.K. surged this year. Italy and Spain have rebounded slightly from last year, as both countries continued to deal with their macroeconomic issues. Interest in Central and Eastern Europe declined noticeably from already low levels to trail all other European geographies. Chart XII Most Attractive European Markets For European country/regionally-focused funds, I find the most attractive markets to be (choose no more than three): Nordic Region Germany United Kingdom Benelux 1 9 Europe via Pan-European funds I do not invest in Europe France Central Europe (Poland, Czech Republic, Hungary, etc.) Eastern Europe (Russia, Ukraine, Georgia, etc.) Europe via fund-of-funds Spain Italy Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1

16 As Chart XIII highlights, European investors view their home market similarly to global investors in terms of greatest areas of interest, but with even more focus on the Nordic Region, the United Kingdom, and Germany. Europeans, as with global investors, remain leery of Eastern Europe, Central Europe, and Southern Europe given the current economic environment. Chart XIV highlights respondents interest in Asian geographies going into 1. China remains the top Asian geography of interest among all parties, though interest continued to decline from its high of 55% three years ago to 8% now. Chart XIII Most Attractive European Markets; European Respondents For European country/regionally-focused funds, I find the most attractive markets to be (choose no more than three): Nordic Region 6 8 United Kingdom Germany Benelux 1 France Spain Italy Central Europe (Poland, Czech Republic, Hungary, etc.) Eastern Europe (Russia, Ukraine, Georgia, etc.) Europe via fund-of-funds Europe via Pan-European funds I do not invest in Europe European Respondents Overall Respondents Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 1 1 Probitas Partners

17 Interest in Japan surged from 9% last year to % this year on the back of the introduction of Abenomics instituted by the new government. The biggest difference between Asian respondents and overall respondents this year is a much greater interest in Japan; however, there were a disproportionate number of Japanese respondents in the survey this year focused on their home market, skewing the Asian results. In last year s survey, % of overall respondents targeted India, while this year only % of overall respondents and none of the Asian respondents were focused on it. Indonesian interest fell to % this year from 1% last year as many investors have made bets on Indonesia over the last two years and now have baseline exposures and are increasingly concerned about liquidity and political stability there. Chart XIV Most Attractive Asian Markets; Asian Respondents Which Asian markets do you find most attractive at the moment (choose no more than three): China Australia Japan Southeast Asia Pan-Asian funds South Korea India Vietnam Indonesia Taiwan Asia via global funds Asia via fund-of-funds I do not invest in Asia Asian Respondents Overall Respondents Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 15

18 Table II highlights how investor interests within the Asian market have changed since the Financial Crisis started. In, China, India, and Japan enjoyed nearly equal investor interest. Since then, interest in India has fallen precipitously as investors grew increasingly concerned over a lack of exits. Appetite for Japan has gone through a cycle of steady decline through 1, then rebounding strongly this year on the back of the economic policies of the new Japanese government. Interest in Southeast Asian funds has increased only over the last three years, driven in part by investor s desire to diversify away from China exposure, while Australia benefits in this year s survey from a large number of Australian respondents targeting their home market. The biggest change in emerging market interest over the last year, detailed in Chart XV, is the increased number not investing in emerging markets nearly double last year, rising from 18% to %. China and Brazil continue to lead investors interest in emerging markets, though interest in both has declined noticeably over the last year. Interest in India continued its decline the last few years as investors complain about the lack of exits from previous Indian funds they backed, while interest in Turkey plummeted as political turmoil negatively affected investor s perceptions. The other BRIC country Russia continued to trail significantly in the survey, as it has for a number of years. Limited partners tell us that they are concerned about investors rights under Russian law. Table II Which Geographies in Asia Are of the Most Interest in Private Equity? Top four responses: 1 Country/Region % Targeting Country/Region % Targeting China 8% China 8% India 8% Southeast Asia % Japan 5% Australia % I do not invest in Asia 5% Japan % Source: Probitas Partners Survey of Institutional Limited Partners, & 1 Private Equity Institutional Investor Trends for 1 Survey 16 1 Probitas Partners

19 Chart XV Most Attractive Emerging Markets Which emerging markets do you find most attractive (choose no more than four): China Brazil Turkey 5 8 Southeast Asia Indonesia I do not invest in emerging markets Pan-Latin America India South Korea Central Europe (Poland, Czech Republic, Hungary, etc.) Colombia Mexico Pan-Asia Russia Peru Eastern Europe (Russia, Ukraine, Georgia, etc.) Chile MENA I only invest in global emerging market funds Vietnam Sub-Saharan Africa Emerging market via funds-of-funds Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1

20 The driving factor that attracted investor s interest in emerging markets was the prospect of strong long-term economic growth that was likely to positively impact returns. However, the number of respondents who felt compelled to invest in emerging markets on that theory dropped from % two years ago to 55% (Chart XVI). For investors who are not interested in emerging markets (Chart XVII), the reasons are much more diverse and not dominated by a single reason. Chart XVI Interest in Emerging Market Private Equity My interest in emerging market private equity is driven by (check all that apply): Strong long-term economic growth in a number of these countries 55 Desire to diversify my private equity portfolio by geography to achieve benefits of lack of correlation 6 I am less interested in emerging markets in general than in exposure to a few specific countries with large opportunities Lower forecast returns in the established markets of private equity make this sector relatively more attractive 18 As an institutional investor from an emerging market, I am looking to support my home markets 1 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 18 1 Probitas Partners

21 Chart XVII Disinterest in Emerging Market Private Equity For those not interested in emerging markets, I am not interested because (check all that apply): I find the risk/return profile in developed markets more attractive I am not staffed properly to perform due diligence on these markets that basically offer emerging manager risk as well as emerging markets risks 8 These markets are not developed enough and it is difficult to find experienced managers with strong track records I am uncomfortable with the degree of political, currency, or economic risk in emerging markets 8 As an organization, we are satisfied to get emerging markets exposure through publicly-traded securities 1 My private equity program is relatively new, and we are focused on building exposure in our core, home markets before diversifying 1 1 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 19

22 U.S. Middle-Market Funds Fund managers in the large, homogeneous market in the United States are predominantly differentiated by investment strategies rather than geographic differences. The majority of respondents indicated a strong preference for funds that generated returns via operational improvements and that were staffed with operating professionals. This is consistent not only with past survey results but also across all investor types (Chart XVIII). Asian investors are more focused on buy-and-build strategies, with % of respondents targeting that approach. The least favored strategy across all investor types are regionallyfocused funds. Chart XVIII Most Attractive U.S. Middle-Market Sectors Which of these sectors/strategies in the U.S. middle market do you find most appealing (check all that apply): Funds focused on operational improvements heavily staffed with professionals with operating backgrounds 6 Funds focused on buy-and-build strategies Restructuring/turnaround funds Funds focused on single industries (i.e., retail, healthcare, media) 9 Strategy is irrelevant, a demonstrable superior track record is my only concern Funds focused on growth companies, often investing without majority control 19 Regionally-focused funds 15 U.S. middle market via fund-of-funds I do not invest in the U.S. middle market Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

23 Venture Capital Venture investor interest in stage and sector remains static over our last several surveys, though interest in cleantech-focused funds has continued to dwindle to a very low level (Chart XIX). Endowments and foundations remain much more active in venture capital than other investors and focused on early stage investments, with 6% of respondents targeting that stage. Since, the number of respondents who do not invest in venture capital has more than doubled, from 1% to %. Asian investors are the most negative on the sector, with 5% of respondents saying they do not invest in it at all, while endowments are the most positive, with all of those respondents targeting the sector. Chart XIX Most Attractive Venture Capital Sectors In venture capital I focus on funds active in the following sectors or stages (choose all that apply): Funds investing in multiple sectors 1 Technology only funds 19 Life science only funds 1 Cleantech only funds Multi-stage Late stage Mid-stage 19 Early stage 6 Seed stage Only historic returns no matter the sector Venture capital via fund-of-funds 8 I do not invest in venture capital 1 5 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1

24 Niche Private Equity Sectors There are several distinct distressed strategies, but many fund managers pursue a combination of these approaches within the same fund. Most respondents prefer strategies with a value-added focus that generates higher multiples of return. In all our previous surveys, restructuring/turnaround funds and distressed debt for control funds have switched back and forth for the lead in the sector (Chart XX). Opportunistic credit funds (that usually have a strong focus on assets other than corporate debt) are another area of focus for investors. While some investors have expanded their distressed debt category to include more credit strategies, others still consider it a straight credit or fixed income product, and therefore not in their alternatives allocation. Chart XX Distressed Investments Within the distressed debt/restructuring sector, I am most interested in (choose no more than two): Restructuring/turnaround funds (focused on equity, not debt) 55 Distressed debt for control funds (loan-to-own) 5 Opportunistic credit (mispriced debt, small loan portfolios, etc.) 6 Distressed debt: active/non-control funds 18 Distressed debt trading funds Distressed debt hedge funds I do not invest in this sector 1 1 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

25 Over the past three years investors have been increasingly focused on the private equity credit sector as they look at opportunities created by the strained bank and CLO markets. Respondents to the survey are more focused on the mezzanine, opportunistic credit, and senior credit sectors, although a number of investors make their commitments to these strategies outside their private equity allocations (Chart XXI). Few respondents to the survey were interested in business development companies or other publicly listed vehicles. Chart XXI Credit In the credit sector, my firm: Mezzanine Senior Debt BDCs/Publicly Listed Opportunistic Credit Does not invest in this sector Considers credit sector investments Invests but not as part of a private equity allocation Invests as part of private equity allocation Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey

26 Chart XXII reflects very few changes in investor preferences since last year, with a large number of respondents actively purchasing secondary positions directly or investing through secondary funds. The secondary market is clearly maturing. The percentage of investors who have sold or are considering selling funds from their portfolio reached an alltime high this year while the percentage of respondents who are not active in secondaries in any manner is at an all-time low. Chart XXII Secondary Market Investments In the secondary market, my firm (choose all that apply): Actively purchases direct positions in funds in the secondary market 5 Actively invests in secondary funds 8 Has sold or is considering selling funds in our portfolio for portfolio management purposes 1 Provides advice to clients on secondaries 19 Is not active in secondaries in any manner 18 Actively purchases direct positions in companies in the secondary market Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

27 As Chart XXIII details, the majority of institutional investors do not pursue coinvestments or direct investments, or only do so opportunistically because of staff or capital limitations. However, the largest investors are much more likely to have an active coinvestment program; 59% of these large respondents have an active internal co-investment program, while another % have outsourced programs and 11% invest directly in companies. Chart XXIII Directs and Co-Investments Regarding directs and co-investments, my firm (choose all that apply): Has an active internal co-investment program 5 59 Only opportunistically pursues co-investments Does not invest in co-investments nor directly invests in companies Provides advice to clients on co-investment or direct investments Invests directly in companies Requires or prefers a co-investment as a means of diligencing a new fund manager Has an outsourced co-investment program All Respondents Large Investors Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Note: Large Investors denotes those survey respondents who plan to commit $5 million or more to private equity in 1 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 5

28 Coming out of the Financial Crisis, there has been renewed interest in publiclytraded vehicles, either at the management company level or the investment vehicle level. However, there remains little interest in investing in this sector among institutional private equity investors, across all types or geographies of investors, a trend that was more pronounced this year (Chart XXIV). Chart XXIV Publicly Traded Private Equity Vehicles As far as publicly traded private equity vehicles, my firm (choose all that apply): Has not made an investment in the sector in the past and has no plans to do so 9 86 Previously invested in the sector but is decreasing or eliminating our exposure 9 Has invested in publicly traded private equity fund-of-funds and plans to maintain or build this exposure in the future 5 Has not made an investment in the sector in the past but is considering doing so Has invested in publicly traded private equity vehicles that invest directly in companies and plans to maintain or build this exposure in the future Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Private Equity Institutional Investor Trends for 1 Survey 6 1 Probitas Partners

29 Fund Structures and Key Terms As with most of our past surveys, the level of general partner financial commitment to a fund remains the most important term for investors as it is one of the key factors in assuring alignment of interest between limited partners and general partners (Chart XXV). European investors were more focused on the level of management fees, with 6% of respondents focused on that attribute, while Asian investors ranked Key Man provisions as second on their list of most important terms. For the first time this year we asked investors how important strict adherence to the ILPA Private Equity Principles or the inclusion of a strong ESG policy was in reviewing fund structures and terms. Overall neither of these issues ranked highly, though % of pension plan respondents targeted strict ILPA compliance and % of European respondents felt that strong ESG policies were important. Asian and Australian investors were least concerned with these issues, and none of the family office or insurance company responses were concerned with ESG policies. Chart XXV Issues Regarding Fund Structure The issues I focus on most when investing or advising a client as far as terms or structure of a fund are (choose no more than three): Level of general partner financial commitment to the fund 6 Distribution of carried interest between the senior investment professionals 8 Overall level of management fees 8 Structure or inclusion of a key man provision 6 Carry distribution waterfalls 6 Cap on fund size 6 Transaction fee splits Ownership of the management company 9 Level of carried interest 19 Structure or inclusion of a no-fault divorce clause 1 Sharing of carry and/or investment decision making with a third-party sponsor Strict adherence to the ILPA Private Equity Principles Inclusion of a strong environmental, social, and governance ESG policy Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey

30 In past surveys we asked investors in more detail about the ILPA Private Equity Principles and found that though few investors insisted on strict compliance to the Principles, a majority of investors of all types used them as a starting point for terms negotiations. After a pause during the Financial Crisis, there has been a resurgence in thirdparty investment in private equity management companies. Similar to our previous surveys, limited partners strongest reaction is that these investments create possible conflicts of interest between investors who acquire positions in general partner management companies and limited partners in the funds (Chart XXVI). Though many investors feel these structures create potential conflicts of interest, only % stated that this would lead them to reject investing in the underlying funds, down from 1% last year. Geographically, there is a distinct difference, with only 5% of Asian investors saying they would reject a fund because of third-party investment in the general partner, while 1% of European respondents said that they would reject such a fund. Only 6% of respondents felt that investing in a private equity management company represented an attractive opportunity. Private Equity Institutional Investor Trends for 1 Survey 8 1 Probitas Partners

31 Chart XXVI Third-Party Investments in Private Equity Management Companies I believe third-party ownership of private equity management companies (choose all that apply): Raises the possibility of conflicts of interest between limited partners and investors 8 Leads me to reject investing in the underlying private equity funds Is better handled through private as opposed to public structures Is a natural response to succession issues in private equity funds Is likely to expand significantly beyond the large funds that have such relationships 18 1 Is irrelevant to the fund investment process Presents an interesting investment opportunity 6 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 9

32 Investor Fears and Concerns The greatest fear of most private equity investors was that large funds are becoming generalized asset managers and are moving away from their key investment strengths. Last year, this was only the third most noted issue with % of respondents mentioning it (Chart XXVII). European investors felt even more strongly about this issue, with 6% mentioning it. The biggest difference geographically was in Asia, where the greatest concern (mentioned by % of respondents) was that too much money was chasing too few experienced private equity professionals in what are becoming overheated emerging markets. Fears that economic difficulties would impact alternative investment returns fell significantly from the first-ranked issue last year (mentioned by 8% of respondents) to only fifth place this year. We also encouraged respondents to state their own greatest fears or concerns not included in our pre-set list. Answers included the following: Fund managers do not have enough skin in the game and as a consequence we are starting to see again practices seen prior to the Financial Crisis in terms of leverage level, especially in the United States. The opportunity is good, but the investment structures are poor. Lack of adequate exit opportunities (IPOs, strategic buyers) to absorb the number of companies that will need to be exited over the next two to four years. Credit bubble fed by aggressive searches of yield will cause another private equity crisis in a few years time. Poor liquidity and distributions. Generational transition at firms when heir apparents likely have modest attributable track records largely from the last ten years. Too much secondary capital to be invested and the rapid increase in coinvestment activity. Large limited partners are not being active enough with their general partners. Are the right funds getting funded, are the right limited partners getting access, are the right entrepreneurs getting funded? Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

33 Chart XXVII Greatest Fears Regarding the Private Equity Market My three greatest fears regarding the private equity market at the moment are: Large firms in the market are becoming generalized asset managers and moving away from key investment strengths 6 Management fee levels and transaction fees on large funds are destroying alignment of interest between fund managers and investors Private equity is most effective as a niche market too much money is being raised in all private equity sectors 6 8 Too much money pursuing too few experienced private equity professionals in the hot emerging markets Economic difficulties will have widespread impact on all alternative investment returns 8 Commitment overhang and allocation pressure will continue to impact my ability to invest in attractive opportunities in 1 Investment by third parties into fund management companies is decreasing alignment of interest between limited partners and general partners 15 Access to top quartile venture capital managers is impossible without previous relationship, and new managers are unattractive We do not have adequate staff in place to deal with issues in my current portfolio 8 8 The private equity market is increasingly illiquid, hampering returns and limiting my ability to reinvest The venture capital investing model is broken and future strong performance is unlikely to return Continued volatile IPO markets will negatively impact venture capital returns The number of funds in my portfolio is too large for my firm to effectively monitor Decreasing opportunities are limiting my access to co-investments I find myself increasingly at odds with other limited partners due to preferential treatment Decreased leverage availability will hurt companies needing working capital or re-financing Another technology bubble is in the process of forming 9 Source: Probitas Partners Private Equity Institutional Investor Trends for 1 Survey Probitas Partners Private Equity Institutional Investor Trends for 1 Survey 1

34 Table III takes us back to the beginning of and highlights investors concerns pre-financial Crisis and compares them to fears going into 1. Concerns about management fees and transaction fees destroying alignment of interest were among the top three concerns pre- and post- Financial Crisis. In investors were very aware that there was too much debt and equity available in the buyout market and that the strong returns leading up to and beyond were unlikely to continue. In this year s survey, nearly half of the respondents were concerned that large firms in the market were becoming asset managers focused on AUM growth and were moving away from their key investment strengths an issue that was not topical in. In, a major concern of investors was that too much money was going into the large market; by 1 the concern was that too much money was going into private equity overall. Table III What keeps you up at night? Top three responses: 1 Issue % Targeting Issue % Targeting Management fee levels and transaction fees on large funds are destroying alignment of interest between fund managers and investors. 51% Large firms in the market are becoming generalized asset managers and are moving away from their key investment strengths. 6% The amount of leverage in the buyout market is unsustainable, and over the next two years credit problems will hurt performance of recent vintage funds. 8% Management fee levels and transaction fees on large funds are destroying alignment of interest between fund managers and investors. 8% There is too much money available in the large buyout market and this will dramatically impact future returns. % Private equity is most effective as a niche market too much money is being raised in all sectors. 6% Source: Probitas Partners Survey of Institutional Limited Partners, & 1 Private Equity Institutional Investor Trends for 1 Survey 1 Probitas Partners

35 Our View of the Future Several key trends for 1 emerge from the survey and our ongoing conversations with investors: Fundraising globally will hit a new post-financial Crisis high this year with continuing strength in 1. Weakness in Asia and emerging market fundraising are being made up by strong interest in North America and Europe, while significant realizations and continued strong public markets valuations are giving limited partners more room to deploy capital. However, the staff of many limited partners is being stressed by a wave of re-ups that is affecting their bandwidth to review new relationships. The new performance metric cash driving increased exits. Many investors have added a key metric of performance to IRR and multiple of capital: distributions on paid in capital ( DPI ), or actual cash returned. This new metric is forcing greater realizations before many fund managers are able to secure new fund commitments. In North America and Europe, increased distributions are leading many investors to recycle cash received into new commitments to funds with solid DPI performance. Investors are becoming more cautious regarding emerging markets. A number of key emerging markets have been plagued by limited liquidity while others have suffered from political turmoil. Though investors believe that the long-term economic growth potential of emerging markets is high, they are less certain of the shorter-term prospects for private equity returns in specific markets, especially compared with what appear to be competitive returns in developed markets with less risk. Interest in venture capital will remain weak but that is not necessarily bad. A large number of investors have given up on venture capital entirely, with % of respondents to this year s survey saying they do not invest in venture capital, the highest mark ever. However, a number of limited partners still targeting the sector believe that the lack of price inflation for venture company investments that should result from less competition should increase future venture capital returns. Increased interest in hard asset plays. A number of sophisticated investors worried about economic uncertainty and future asset shortages, as well as those seeking to match long-term liabilities, are increasingly turning to hard asset sectors such as energy, agriculture, mining, and timber. Several pension funds have created separate inflation-linked allocations outside of their private equity, real estate and debt allocations, though many investors with these allocations express frustration because there are few products available with experienced management teams and deep track records. The past as future middle-market, operationally-focused funds. In all of our past surveys and conversations with investors, there has always been a pronounced preference for middle-market buyout funds with operational focus. We do not expect that to change prospectively. What does continue to vary on the topic, however, is the definition of what middle market is, or what defines an operational focus. Given increased interested in the space, we expect to see broader definitions emerge. 1 Probitas Partners Private Equity Institutional Investor Trends for 1 Survey

36 Private Equity Institutional Investor Trends for 1 Survey Probitas Funds Group, LLC Probitas Funds Group, LLC PFG-UK Ltd. Probitas Hong Kong Limited 5 California Street Suite San Francisco, CA 91 USA 11 Ave. of the Americas Suite 18 New York, NY 16 USA th Floor Egyptian House 1-1 Piccadilly London, W1J 9EJ UK Nexxus Building Level 15 1 Connaught Road Central, Hong Kong Tel: Tel: Tel: + () 85 5 Tel: