Pressure on manager selection in next phase of private equity

The party’s not completely over for private equity, but the next phase of the business cycle is placing greater importance for investors on manager skill and selection.

According to a report by Watson Wyatt, there seems to have been a turning point in the cycle for private equity, following the recent market volatility. The main fallout from the changes to market conditions will mean that: . Private equity managers who rely heavily on debt to finance buyouts will struggle to complete transactions and, therefore, deal activity will slow. . There will be a fall in prices which buyout funds are willing to pay for deals as managers are forced to provide a larger proportion of equity in deals. . The days of recapitalisations providing early liquidity and a boost in the internal rate of return seem to be – temporarily at least – over. . Buyout firms will be forced to hold their investments for longer to give the underlying companies time to ride out market cycles prior to exit. Deployment and realisation rates will slow. . There will be a reduction in expected private equity returns from recent highs. But Watson Wyatt says that high quality managers with the required skill, experience and expertise to add value to portfolio companies will generate returns in excess of public markets. This means that manager skill and selection by investors has become even more important than ever. “We also believe that investors can position themselves to minimise the negative impact of recent developments and potentially benefit from some opportunities that might arise,” the consultants say. “Most importantly, we believe that successful private equity investors maintain a consistent, long-term and diversified approach to making commitments and therefore we urge investors to avoid attempting to time the market.”