Specialization

Specialization: As the private equity environment gets more competitive, some firms are finding an advantage by specializing in specific sectors. And according to a new study from Cambridge Associates, their limited partners are benefitting from their specialization.

Sector-focused funds have returned an aggregate 2.2x multiple on invested capital and a 23.2 percent gross internal rate of return between 2001 and 2010, Cambridge said. That compares to the 1.9x multiple and 17.5 percent gross IRR returned by generalist funds during that time period.

Cambridge defines sector-focused funds as those that invest more than 70 percent of their capital in the consumer, financial services, healthcare or technology sectors.

“In an increasingly competitive private equity environment, a manager’s ability to demonstrate deep expertise in a focused field is a key differentiator,” Andrea Auerbach, global head of private investment research at Cambridge, said in a statement.

The challenge for LPs is to determine who is really a sector expert, Auerbach said in an interview.

Many firms claim to focus on several sectors, but it’s important to determine if they “live and breathe” the sector, or if they are simply calling themselves specialists “so the right sector banker can find you with their deal flow,” Auerbach said.

“You can have sector-focused individuals, or teams within larger firms who are ultimately competing against complete firms [where] that’s all they do is that sector,” Auerbach said.

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SEC probing private equity performance figures: Reuters

The U.S. Securities and Exchange Commission is examining how private equity firms report a key metric of their past performance when they market new funds to investors, as the regulator boosts its scrutiny of the industry, according to people familiar with the matter. At issue is how private equity firms report how they calculate average net returns in past funds in their marketing materials, the sources said. Net returns, also known as the net internal rate of return (IRR) and an indicator of investors’ actual profits, deduct private equity fund investors’ fees and expenses from a fund’s gross profits. Private equity fees are not standard and different investors in the same fund can pay different fees. Fund investors such as pension funds, insurance companies and wealthy individuals – known as limited partners – pay the fees to the private equity firm. The private equity firm and its managers, called general partners, also typically invest some of their own money into the funds, but don’t pay any fees. Including the general partner’s money in the average net returns can inflate the fund’s average net performance figure, and the SEC is investigating whether private equity fund managers properly disclose whether they are doing that or not, the sources said. An SEC spokeswoman declined to comment. The SEC’s focus on the average net IRR disclosures, which has not been previously reported, marks a new phase in the agency’s efforts to regulate private equity and comes at a time when the industry is already under pressure from investors to simplify its fees and expenses structure. The emphasis on performance figures is likely to cause many buyout firms to review their regulatory compliance measures and force them to increase disclosures and make their numbers more intelligible to investors.There is no standard practice for calculating average net IRRs among the roughly 3,300 private equity firms headquartered in the United States. A Reuters review of regulatory filings and interviews with people familiar with different firms’ practices show the calculation varies widely even among the top private equity firms. Blackstone Group LP, Carlyle Group LP and Bain Capital LLC, for example, do not include money that comes from general partners in average net IRR calculations, while Apollo Global Management LLC does, the review shows. Fund marketing documents are not public, but the sources said all these firms disclose to investors whether they include general partner capital in the calculation or not. The SEC’s review comes after the agency put together a dedicated group earlier this year to examine private equity and hedge funds that had to register with it as part of the 2010 Dodd-Frank financial reform law, Reuters first reported in April. Much of the SEC’s focus so far had been on fees that private equity funds charge. In a May 6 speech, Andrew J. Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said more than half of the private equity funds the agency examined had inappropriately allocated expenses and collected fees. COMPLEX CALCULATION The average net IRR figure is crucial to investors’ understanding of their actual profits from private equity funds. To continue reading this story, please visit peHUB.com. By Greg Roumeliotis

Changes in Investment Needs to think about

Melbourne Mercer report deems Danish pension system best in world

Denmark has retained the only “world-class” pension system, while the Netherlands has fallen to third place behind Australia, according to the latest Melbourne Mercer Global Pension Index.

New European entrants include Finland, which came fourth and claimed the highest-ever integrity rating of 91.1, while Austria and Italy ranked 17^th and 19^th, respectively, behind France and Poland, largely due to the each country’s pension sustainability ratings.

The Index, in its sixth year and written by David Knox of the Australian Centre for Financial Studies in Melbourne, assesses pension systems on the three broad categories of adequacy, sustainability and integrity.

Italy set a record for the lowest overall sustainability rating, which takes into account coverage, contribution levels, demography and government debt, with a score of 13.4 in the category, slightly behind Austria’s 18.9.

The worst sustainability score to date was achieved in 2013 by Brazil, when it scored 26, a rating that this year improved marginally to 26.2

The final new European entrant, Ireland, ranked joint 12^th overall, the same as Germany.

Ireland earned a score of 62.2, with a higher adequacy rating than neighbouring UK but ranking significantly behind on sustainability.

Score of European countries within Index
Country (Ranking)	Score
Denmark (1)	82.4
Netherlands (3)	79.2
Finland (4)	74.3
Switzerland (5)	73.9
Sweden (6)	73.4
UK (9)	67.6
Germany / Ireland (12)	62.2
France (14)	57.5
Poland (15)	56.4
Austria (17)	52.8
Italy (19)	49.6

Denmark saw its overall rating increase to 82.4 due to improvements across all three categories and increased its lead over both second-ranked Australia and the Netherlands, with scores of 79.9 and 79.2, respectively.

The report praised the Nordic country for improving protection of benefits in cases of fraud or provider insolvency, but noted that the better score had been influenced by several minor factors including a higher savings rate.

Australia, meanwhile, was congratulated on increasing the rate of the mandatory contribution to Superannuation funds from the current 9.5% to 12%.

However, the Australian government last month announced that the current rate would be maintained until 2021, with the increase to 12% now occurring by 2025 rather than the initially planned 2019.

The Netherlands, which saw its score increase by 0.9 points to 79.2 compared with 2013, was praised for changes to the conflicts of interest policy.

Top 10 Countries within Index
Country (2013 ranking)	Score
Denmark (1)	82.4
Australia (3)	79.9
Netherlands (2)	79.2
Finland (-)	74.3
Switzerland (4)	73.9
Sweden (5)	73.4
Canada (6)	69.1
Chile (8)	68.2
UK (9)	67.6
Singapore (7)	65.9

It is unclear if the research was already able to take account of the recent changes to the financial assessment framework (FTK).

Knox stressed the importance of communicating clearly and concisely with fund members, as the effectiveness of a system was undermined by lack of community trust.

He also said the increasing importance of private provision over state pension payments meant communication would be key.

“This shift means communication to members has never been more important or come under more scrutiny from members, regulators, employers, consumer groups, politicians and the media,” he said.

France and Germany both saw significant increases in their overall ratings, with France’s 4 point rise to 57.5 credited to an increase in the minimum level of pension.

Germany, which saw a slightly smaller score increase of 3.7, nevertheless saw its grade improve from a C to C+, as its score rose to 62.2 due to changes to the provision of annuities.

Ireland was told it could increase its score by introducing a minimum level of contributions to occupational pensions, a move that would be made possible through the Irish government’s potential auto-enrolment reforms.

Auto-enrolment, and the rising contribution rates, benefited the UK, which saw its score rise by 2 points to 67.6, resulting in its overtaking Singapore and remaining ninth, despite Finland’s entry into the Top 10.

Poland slipped behind France to 15^th after its score fell to 56.4 after declines in both its adequacy and sustainability ratings, while its integrity rating remained unchanged over 2013.

The report urged Poland to maintain a “significant” role for the country’s second pillar – months after the state transferred all of the second pillar’s domestic sovereign debt to the Social Insurance Institution (ZUS) – and to allow at least part of the private savings to be drawn down as an income stream.

Sweden retained its strong position in the Index, increasing its overall rating and only falling to sixth due to the addition of Finland, with Switzerland’s rating remaining constant and also falling one spot to fifth.

The Rise and Rise of Direct Lending

Both a slew of announcements on new platforms and the hard data point to the rise of direct lending.

Private Debt Investor - PEI article
 I joined Private Debt Investor two weeks ago. And over those two weeks, announcements about new direct lending funds have dominated our reporting. They have also dominated our top ten most read stories.
I am very excited about my new role here at PDI – to head up a publication about an up and coming asset class as the market grows, develops and forces people to pay it some attention is a great opportunity.
We’ve had a slew of stories about new direct lending moves by Sankaty Advisors, Angelo, Gordon & Co., Blackrock, Cowen Group and Benefit Street Partners. And all these in my first two weeks in the job have just served to boost that sense of excitement.
Sankaty are targeting a fund of $700m to $1bn to invest globally. The firm, the credit arm of Bain Capital, will focus the new fund on senior secured debt for mid-market companies. Michael Ewald’s direct lending team will manage the sector-agnostic fund.
Blackrock is in the very early stages of launching a direct lending strategy. They have hired Stephan Caron, formerly chief commercial officer at alternative lender GE Capital, as European head of direct corporate finance – a newly created role.
Angelo, Gordon & Co. have hired former Madison Capital Funding duo, Trevor Clark and Christopher Williams. The new direct lending platform will target mid-market companies with EBITDA of between $3 million and €5 million.
Not to be outdone, Cowen Group also announced their new direct lending strategy last week. The group will initially invest $125m in Cowen Finance, which will originate and syndicate loans to the firm’s corporate clients.
Also making a strategic hire to lead their move into direct lending is the credit arm of Providence Equity Partners, Benefit Street Partners. They have hired Tim Murray, formerly managing director at GSO Capital Partners, to effectively open an office in Houston, Texas and establish a mid-market energy company credit business.
Benefit Street is both moving to tap the trend for direct lending, and take advantage of the US domestic energy boom prompted by the rapid expansion of shale gas production.
All these stories are not a coincidence, the data backs up the anecdotal evidence. Funds raised for private debt strategies have grown over the last few years, up from $39.61 billion in 2011, to $50.85 billion in 2013. More importantly, the proportion of those funds dedicated to debt origination, rather than strategies focused on buying debt in the secondary market, has exploded.
In 2011, funds raised for origination made up 3.6 percent of the total. After a small increase in 2012, it surged to 25.6 percent. In the first six months of 2014, the proportion of origination funds raised has risen to 30 percent, according to research by PDI Research & Analytics.
The trend has been driven by both push and pull factors.
European banks, in particular, are deleveraging. Loan growth in Europe has been negative since 2012, with lenders shedding assets and avoiding taking on new exposure. That has opened up a clear gap in the financing market with mid-market borrowers especially under-serviced.
For banks globally, the new Basel III standards will require them to hold more capital against loans, making corporate bank loans, already sometimes a loss leader, an even less attractive business.
On the push side, many of those moving into direct lending cite the low yields on offer in other asset classes. Mid-market corporate lending has generally low default rates and companies in need of capital, will pay for it.
So far, so familiar – none of these factors are earth shattering news to most financial market participants.
The really interesting question is how many of these new direct lenders will manage to find the right opportunities to scale-up? The other issue is returns – will the apparent rich pickings of low risk with decent yield meet expectations?
And for me, the most interesting points – will these new ventures still be here five years from now? And what form will they have taken by that point?
It’s a vibrant and growing market. We’ll be watching its progress with interest.