Co-investment programmes placing money in private equity are becoming increasingly popular, even though investors face downside risk if such vehicles are poorly executed, reveals a new survey.

Co-investment programmes placing money in private equity are becoming increasingly popular, even though investors face downside risk if such vehicles are poorly executed, reveals a new survey by Altius Associates, an asset management firm specialised in private equity.

Without making structural adaptations many LPs can face difficulties in evaluating an investment relative to their portfolio, performing due diligence, preparing a recommendation and gaining approval from their investment committee within a matter of weeks, the firm explained in a statement.

The report, which looks at challenges to the private equity market on a regional basis, said that one of the key challenges in Europe, is how to maintain investment and pricing discipline whilst deploying a significant amount of dry powder. However, the overall picture is postive as international investor concerns regarding the stability of Europe and the Euro have abated over the past 12 months in favour of greater enthusiasm. Key trends include moves to invest in Southern Europe and a number of groups raising new funds in 2014.

“Fundraising continues to remain a challenge for some, and for European managers aiming to attract international money, regulatory changes such as AIFMD continue to add some uncertainty going forward. We also expect the bifurcation in European fundraising that has been seen over recent years to remain. Whilst some funds will raise capital relatively easily, others will struggle and ultimately fail to reach their target,” said Rhonda Ryan, head of EMEA investment at Altius.

Asian private equity remains strong

Turning to Asia, the firm argues against the prevailing perception that cash distributions are continuing to slow down with managers struggling to return capital and recommends investors continue to grow their programmes in a disciplined and highly selective way as conditions for investing seem generally better compared to anytime over the past few years.

“As a result, certain GPs in the market with new funds have been oversubscribed and select emerging managers with experienced teams and differentiated strategies have also seen strong investor backing. The current challenge for LPs is to refocus resources and attention on Asian private-equity investing by taking a long-term view, in a market that is asymmetrical, highly heterogeneous and still relatively young,” said Peter Pfister, head of Asia-Pacific.

Emerging markets remain risky

In emerging markets, the firm said that while investors have been increasing their allocations over the last 10 years, exits still lag far behind and this is reflected in a significantly lower distributions to paid-in ratio than the US and Europe. The key reason for this being the focus on growth capital investments, which generally takes longer to create value than buyouts.

“The median for funds raised between 2003 and 2012 was 35.2% for the US, 28.6% for Europe and only 11.6% for Emerging Markets. We believe that the substantial lower DPI ratio in Emerging Markets is essentially the consequence of the type of investments that are being pursued in these markets. Indeed, the vast majority of the investments are made in fast growing companies by providing growth capital. For these companies to get to a size which becomes attractive to trade buyers or the public market, it generally takes longer than for a buyout manager to create value on its companies,” explained Elvire Perrin, investment partner at Altius.

Conversely, the firm said that it was expecting a more robust market in the coming year, driven by a recovery in primary fundraising, changing regulations and a substantial opportunity in fund restructurings and secondary direct transactions.

In addition, the firm urged “caution – and a significant underweighting – for real assets in emerging markets and predicts that 2014 will see the bloom finally fall from the rose of renewable energy”.

Regulation causing issues for sector

Finally, Altius said that the private equity sector is increasingly challenged by having to provide advice in an environment where overall fees and costs are often considered more important than investment returns. For instance, the growing focus on cost savings is driving institutions and advisors to apply a ‘low cost’ commoditised approach or a higher risk strategy of using co-investments to ‘reduce costs’. In addition, investors are frequently eschewing experienced advisers for general consultants with less experience at an in-depth level in the asset class.

“Institutions need to achieve good returns in order to meet the challenges of providing for their stakeholders in the future, cutting costs in the short term may make the current cohort of management look good, but it will do little to solve the problem of future liabilities,” the report concluded.