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Industry Viewpoint - Fall 2009

What Next for Private Equity? - continued

The Principal

Jeremy Coller

It is inevitable that the private equity industry will be successful. To understand its true potential, you need to put the buyout boom years and the current market difficulties to one side and consider the bigger picture.

Look at the changes to the investment landscape over the last 150 years. The mid 19th century marked the beginning of the modern concept of the limited company. Whereas previously these needed to be created by an Act of Parliament, the UK’s system of incorporating a company through a simple registration procedure, introduced in 1844, was rapidly copied throughout the world. Despite this, ownership was limited to private wealthy individuals.

The creation of large aggregation vehicles such as pension funds in the 1950s and 1960s marked the beginning of institutions holding shares for the benefit of policyholders and investors. In the 1970s these institutions became the majority owners of large public companies. Consider the amount of capital held by insurance companies, corporate pension plans and state-controlled pension funds, and the fact that until comparatively recently these entities could only invest in equity through the public markets.

The private equity industry started on a very small scale but in the mid 1990s there was a massive explosion of money chasing private equity. The industry will continue to grow over the coming decades before reaching equilibrium at a much higher level than it is today. Of course, the market for private equity is cyclical like any other, so there will be peaks and troughs like the ones we have experienced over the last few years. But over a longer period we will see growth.

The rise of private equity secondaries is also inevitable. It’s true that growth of the secondaries market is a natural consequence of the current liquidity shortage, but that is far from the whole story. For a long time, investing in private equity was a game of buy and hold. The secondaries market provides a way out for investors that will become increasingly attractive.

The dynamics of private equity investing have changed enormously since the onset of the credit crunch, but the make-up of investors’ private equity portfolios largely reflects pre-credit crunch conditions. Many investors – even those not facing liquidity issues – will consider selling assets in the secondaries market simply to help them reshape their portfolios in the light of new economic realities.

Momentum in the secondaries market will pick up during 2010 as private equity valuations become more realistic and the volatility of financial markets reduces. In addition, the re-starting of investment in the primary market will result in a flurry of capital calls creating acute liquidity needs for many investors. We will also see some institutions come under pressure from CIOs or trustees to sell private equity assets in order to adhere to their funds’ asset allocation policies.

Finally, you will start to see a much bigger difference between the returns generated by the best- and worst-performing managers in industry. For many years, investors were able to throw money at the private equity industry almost indiscriminately and achieve incredible returns. Everyone made money. Now the skill a general partner brings to the table is incredibly important, and you will see more investors looking to switch horses before a fund is fully realized.

Jeremy Coller is the founder and CEO of Coller Capital, a leading secondaries firm with offices in New York, London and Singapore and $8 billion under management.