The private equity sector has quickly shaken off the corona crisis. The number of deals increased in the second half of 2020 after a dip in the first six months, according to the financial auditor and consultancy group EY . For the full year, transaction values rose to 34.6 billion euros in Germany from 32.2 billion euros in 2019, despite a slight fall in the number of deals to 221 in 2020 from 225 a year earlier. (EY, December 29, 2020).
Universal-Investment also reported continued investor demand for private equity and alternative investments. Invested capital in fund vehicles focusing exclusively on alternative investments in Germany and Luxembourg increased to almost 57 billion euros at the end of 2020 from 50.6 billion euros a year earlier. Growth has thus continued unabated from the 2012 level of less than 1 billion euros. Invested capital in private equity structures also increased, rising to 33.5 billion euros in December 2020 from about 30 billion euros a year earlier, and from 12.3 billion euros in 2016 and 4.5 billion euros in 2014.
Institutional investors avoided any radical strategic changes in 2020, according to Universal-Investment’s regular 360-degree analysis of institutional investor behaviour. The analysis, unlike the figures above, includes all of Universal-Investment’s investments in special funds in Germany. Invested capital amounted to about 442 billion euros. This corresponds to around 22 percent of the almost 1,998 billion euros in invested capital in special funds recorded by the German Investment Funds Association (BVI) as of December 31, 2020. The figure provides a clear picture of institutional investor behaviour in Germany. While the share of bonds (42.2 percent) continued to increase slightly year-on-year and the share of equities jumped to 25.3 percent in 2020, the highest level since end 2017, the alternative investments share rose to about 15 percent. Sub-segments including private equity, private debt and infrastructure also grew.
There are several reasons for continued investor interest in private equity:
- Private equity can offer investors comparatively attractive and stable long-term returns with manageable risk. The asset class often has low correlations to other asset classes.
- The asset class often has low correlations to other asset classes.
- It allows diversification beyond that of traditional asset classes.
- Private equity investments are typically highly diversified in terms of industries, ownership duration and regional focus.
These features have gained in importance in the coronavirus pandemic. Indeed, the low interest rate environment looks set to continue, further fuelling investors’ appetite for higher yielding investments. Universal-Investment’s 360-degree analysis highlights the resilience of the asset class: private equity funds delivered a 2.9 percent return on an annualised basis as of January 31, 2021, stronger than the 2.6 percent recorded by pension funds although below the 4.9 percent by equity funds. Over a five-year period, private equity funds’ annualized 7.9 percent return outperformed equity funds (7.5 percent) and pension funds (3.4 percent).
Given the popularity of private equity funds, Universal-Investment expects a continued inflow of funds into the asset class. Further trends and observations are also evident:
- ESG, a crucial topic for the financial industry as a whole, is also becoming increasingly important for private equity. Companies that tackle climate change are in the spotlight.
- The investor base is expanding. More and more investors who were previously indifferent to private equity are now turning to the asset class.
- Germany is catching up with international competition as a fund domicile. Until now, alternative investments have played a far greater role globally than in Germany. Interest in innovative German fund solutions is growing, for example in private equity via special AIFs with a broader range of permissible investments compliant with § 282 of the German investment code (KAGB).
- US asset managers are increasingly turning their attention to the European private equity market, aiming to find investment solutions that can be marketed throughout Europe.
- Appetite for niche market investments is growing: investors are frequently focusing on individual markets and industries, such as fintechs.
- Investors prefer well-established structures and structuring partners.
The preference for established structures and structuring partners is linked to the specific challenges of private equity: it is not without risk, is comparatively complex, and it has a lengthy capital commitment period. In addition, private equity is less liquid than the traditional asset classes of equities and bonds, while performance- and risk assessment are more complex. Finally, investors appear to be more aware of the structural risks of this asset class due to the corona crisis and to value its stability higher.
Institutional investors and fund initiators benefit from:
- well-negotiated issuer contracts
- regulatory compliance
- qualitative risk management
- smooth capital flows and accounting
- transaction costs kept to the minimum
- swift transactions
Transaction management and due diligence are crucial. It is important that investors in private equity comply with legal requirements, regulations and guidelines, that they are transparent about investment risks, and that they limit losses. It is therefore vital that documents, investor-specific issues as well as contractual and legal investment limits and their implementation are monitored.
With many years‘ experience as a structuring partner for alternative investment funds (AIFs), Universal-Investment, provides institutional investors and fund initiators with access to the attractive asset class of private equity. As a German investment management company (KVG), it helps clients tailor and structure private equity investments, provides AIF management services in different locations and covers a wide range of target investments and investment structures. Transaction management, due diligence, structuring and risk management are also part of Universal-Investment‘s service range. For fund initiators who want to develop investment ideas themselves and to deal with their own portfolio management, Universal-Investment takes over the entire administration and also provides a range of complementary services. Given the complexity of these requirements, a “one-stop shop” offers real benefits for all client groups: everything is covered by a single source.
Clients choose their preferred fund domicile based on their requirements. Luxembourg has so far proved to be the clients’ favourite location. A potential basic structure is the Luxembourg SICAV-SIF / RAIF in the legal structure of an SCS (Sociétéen Commandite Simple) or S.A. (Société Anonyme). Launched in June 2020, Universal-Investment’s Luxembourg- based investment platform provides institutional investors with far smoother and faster access to alternative investments because the key elements of the fund structure are already in place there. Universal-Investment also offers solutions in Germany that are compliant with Section 282 of the German Investment Code. In addition, it will be possible as of summer 2021 to launch funds in Universal-Investment’s new location in Ireland. The Irish Limited Partnership, a new fund structure that is based on Irish law, offers advantages for private equity investors in particular.
Overall, the Covid-19 pandemic has failed to suppress investor appetite for private equity - on the contrary. Investors have, however, become acutely aware of the importance of resilient and sound transaction structuring and the support of an experienced partner. Private equity remains an attractive but challenging asset class.
Author: Dr. Sofia Harrschar, Universal-Investment
Date of issue: 8/10/2021
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