A tough fund-raising environment often results in a flight to quality. With the benefit of sound investment advice, investors can seize the opportunities this represents.
In 2011, private equity experienced a strong first half. But new concerns about the global economy arose after a third-quarter slowdown created an atmosphere of uncertainty going into 2012.
During 2011's third quarter we witnessed1:
Yet there are positives in this type of market. While consolidation is expected throughout the private equity industry, the surviving, seasoned performers will be in an even better position to attract investors and identify opportunities due to less competition. In short, Northern Trust is anticipating a flight to quality that may result in solid returns for investors.
Turbulence like we experienced during 2011's third quarter makes forecasting tough, said Bradley M. Dorchinecz, senior vice president and private equity portfolio manager at Northern Trust, but there's still good news for investors who receive informed guidance. "Tough years like this typically produce good fund vintages because there's less competition for deals and a flight to real quality funds," he explained.
Academic research supports this notion. In a paper published in spring 2010 by Steven N. Kaplan of the University of Chicago Booth School of Business and Josh Lerner of the Harvard Business School, the researchers note that periods of low fund-raising, such as 2009, are usually followed by above-average returns.
"Based on the historical relationship between commitments and performance, the low level of commitments suggests that returns to the 2009 and 2010 vintage years are likely to be relatively strong," the authors wrote.
Dorchinecz said this scenario is likely to remain unchanged for now. "We expect fundraising levels to remain relatively low and the potential for high returns to continue into the next few vintage years," he said.
Dorchinecz stressed that investors need to be in the best funds to reap the rewards. "The elite funds will still be oversubscribed," he said. "Those investors who remain in the market will be more discerning about where they invest their money." He noted, for example, that endowments and foundations â€“ generally considered blue-chip investors in the private equity arena â€“ now are looking at investing in three or four partnerships, whereas they might have chosen 10 or more in previous years.
So how do investors identify the top-tier funds and, more important, how do they gain acces to these partnerships?
"We believe partnering with an experienced advisor is a crucial step in the search for quality," Dorchinecz said. "We can help investors navigate tough markets such as the current environment and provide access to the top-tier funds."
1 Preqin Ltd., October 2011