Graham Elton: After Many Happy Returns, Time for a New Strategy for Private Equity




It has been a record few years in private equity, but there are clouds on the horizon. Graham Elton, a partner in the Private Equity practice, discusses the importance of a coherent strategy for private equity firms going forward.

Read the transcript below.

GRAHAM ELTON: The sun is shining in the world of private equity. It's been a fantastic couple of years actually for almost everyone in the private equity industry.

Exits are at an all-time high. Money is flowing back into LPs' hands, and the returns on that money have been pretty good as well: the long-term returns, 10-year numbers for private equity, [are] 3.7% ahead of public markets. LPs are loving it. They want more of it. They're pouring money back in. Fundraising, it's easy street. It's never been a better time to raise a fund. In fact, if you can't raise a fund now, you'll never be able to raise one. Even the fourth-quartile funds, on average, have been achieving their target.

But there are a few clouds on the horizon. This is, as everyone in the industry knows, a pretty difficult time to be putting money to work. It's difficult for a number of reasons. First of all, there's pretty intense competition from corporate acquirers, who have got a lot of cash that they're looking to put to work to fund their own growth.

There's competition from public markets. The IPO markets have been back alive and kicking over the last couple of years, and there's competition from what the industry's calling shadow capital from the LPs themselves putting money to work through co-invest and through being direct investors.

All of that means lots of dry powder, lots of competition and high prices. The multiples being paid in the last year or so have been at the very top of the industry. How can you drive returns now looking forward from that, when really beta isn't going to be doing much of the work for you? It's got to come from your own endeavors, from alpha.

And this is now at a time when we're probably sailing into rather choppier waters. Most economists would be agreeing that there's going to be some form of economic slowdown in the Northern European, North American economies over the next two to three years—so within any reasonable investment time horizon. So how do you equip businesses that you're buying now at top prices to do well in that kind of climate? And these are the deals that investors are going to be judged on when it comes to the next fundraising, and the next fundraising is going to be nowhere near as easy.

The fire hose of money that has been coming out from exits will slow down. It'll probably slow down by anything up to a third if we look at the amount of money that's been invested over the last five years by the private equity industry relative to the amount that was invested in the five years before that. So you'll be fundraising private equity GPs at a time when your more difficult deals are being assessed and when the amount of money available from LPs will have reduced.

How do people equip themselves for that? We think it's never been a more important time than today to get your own strategy straight. Which bits of the market are you really going to focus on? More importantly, how are you going to differentiate your acts, so you're able to do the deals that you do better than anyone else and add value to them better than anyone else can? The laws of competition and competitive strategy are now very much at work within the private equity industry, and we can see the best funds putting their real endeavors behind that, not only so they've got a good story to tell at [the] time of next fundraising, but also to deliver the great returns that their investors are expecting.

Read the report: Bain & Company's Global Private Equity Report 2016