Private equity players say they are all weather players. They admittedly look for growth stories and value multiplication of investments. Most PE investors say their investments are not valuation-specific, and they do not mind paying higher valuations if there is growth potential. But the actual PE investment trend, over time, throws up an opposite picture. An analysis of PE investments made in India between 1998 and 2008 shows that PE investors remained silent during the bear period barring some one-off deals, and they aggressively invested during the bull-run even at higher valuations.
To successfully execute a PE investment, a fund manager needs to identify and access an investment opportunity, finance the company through a properly structured instrument, create new shareholder value and realise it via an advantageously structured and executed ‘exit’ transaction. Superior investment return is not the only reason why more and more investors are turning to PE. A sophisticated investor holding a typical portfolio of publicly traded stocks, bonds, or real estate could improve the portfolio’s risk profile by investing some assets in PE.
Studies have shown that the returns on PE are directly correlated to the equity markets, resulting in even stronger benefit of diversification during boom times. The same studies indicate that a portfolio weighting of up to 10% in PE provides investors with significant risk reduction as a result of diversification during a bearish trend.
The complexity of this investment cycle explains why fund managers’ domain expertise is of crucial importance for achieving superior returns on PE investments. To illustrate what return could be achieved by PE expert investors, consider this example. Over the course of more than 40 years of the history of the American venture capital industry, there have been several hundred cases in which fund managers were able to increase investor capital by 10 to 100 times in just four to six years by investing in innovative new companies in the fields of information technology and telecommunications.
Though valuations in India at present look attractive in clear numerical terms when compared to peak-time valuations, the inability of any fund manager to assess and arrive at how long the gloom time will prevail is a billion-dollar question. This may not find any right answer in terms of periodicity, and that is why PE players say, "Let us get knowledge during the boom time, and when the overall signals of a come-back trend surfaces, start taking aggressive investment positions."
The logic behind PE players’ aggressive investment posture during bull-runs can be attributed to many factors: (i) PE funds pool in funds from companies, pension funds, and high net worth individuals who tend to subscribe to these funds only when they see a turnaround in markets and global economy (ii) The performance of PE funds becomes visible only during a boom time, which in turn helps them raise any number of follow-ons. (iii) The evolution of venture capital in large-size is PE fund, and so valuations and associated returns and turn-around time too count a lot (iv) Recapitalisation happens quickly during boom times.(v) Leveraged investment possibilities are ample during boom time.
Currently, the Sensex is quoting at a price-earning multiple of about 15.23, when compared to peak-time multiple of 22.45 a year ago. PE funds aggressively invested during the boom time. The present PE investments may purely be driven on the basis of valuations, turn-around time and may happen very selectively and rarely for the following reasons: (i) Funds have become scarce and investors have become fussy due to the negative returns at this point of time. (ii) When it comes to diversified investments vs focussed investments, given a chance, investors are now looking for future stories and sectors that can emerge after this downtrend.(iii) Most of the fund managers are facing flak from investors as some of them could not use the boom time for good exits on behalf of the investors. (iv) Bottomed-out valuations and levels have become a big question mark. (v) PEs look at attractive annualised returns upon exits, so they are no charity houses to ignore the downtrend in global economy. When the global economy is not doing well they look at stories wherein promoters desperately look for funds at lower valuations with good growth potential.
Though the right time for investments by PE funds is, in general, the time at which valuations look attractive, investments rarely take place except for strategic reasons. Though PE funds talk a lot on growth story and value-based investments, they do get into the quick-return bandwagon and invest aggressively during boom times. And bear times seldom attract investments irrespective of a great profitable proposition.
(Source:Financial Express)
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