Private equity firms and their investors on a collision course

Wed Sep 26, 2012 4:59pm EDT

* Returns of 15 pct should be new norm in current climate-TPG's Bonderman

* Volatility comes with private equity-Champ founding partner

* Institutional investors have return pressures too-Canada pension fund

By Michael Flaherty and Stephen Aldred

HONG KONG, Sept 27 (Reuters) - Pension funds and endowments are pressing private equity firms hard to boost returns amid a global economic slowdown, just as buyout executives set off on a new round of multibillion-dollar fundraising.

The tension between private equity firms and their institutional investors is rising, with pension funds also wanting more exposure to specialised investments rather than just broadly themed funds. Some buyout bosses believe that may not be such a good idea.

"We're seeing a trend away from one-product-fits-all, to things that are more narrowly tailored," David Bonderman, a founding partner of TPG Capital, told a panel in Hong Kong at the Asia Super Return industry event. "It's likely that it will turn out to be not a happy thing for these folks."

The diverging paths of private equity firms and their investors could have a big impact on the fundraising plans of the buyout industry at a time when returns are already suffering from volatile markets.

About $130 billion is being sought for investments in Asia by 386 private equity funds, according to data provider Preqin. Of this sum, major firms KKR & Co, TPG, Carlyle Group and RRJ Capital are targeting raising nearly $20 billion.

Bonderman said institutional investors, known as limited partners (LPs), are saying now they want a portion of their money invested in markets like real estate, technology or India, in exchange for a different fee and profit-sharing structure.

"If I raise a fund for insurance in Sichuan, it may be that 80 percent of the time you shouldn't be investing in insurance in Sichuan, you should be investing in insurance in Mumbai. Or you shouldn't be investing in insurance at all," Bonderman said.

"The narrower the choice the GP has, the less likely the ultimate returns are to be good. The risk-reward is all wrong and LPs haven't figured that out yet," he said. General partners (GPs) are the entities managing the private equity funds.

Bonderman said the 25 percent return expectation of the LPs is "trapped by history", in a market where global stocks have been largely flat for a decade, and where interest rates are at zero.

Investors in private equity, in the current environment, should be happy with a 15 percent return, he said.

INVESTORS TOO UNDER PRESSURE

Pierre Fortier, an emerging market investor into private equity for Canada's second-largest pension fund, said investment expectations remain high because LPs themselves face pressure to generate strong returns.

Fortier, speaking on a panel on Wednesday right after Bonderman and several other managers spoke, said return targets have fallen into the 15-20 percent range in recent years.

"So LPs are managing expectations, but at the same time we have a lot of pressure coming from our shareholders to generate a minimum rate of return that we have to pay," said Fortier, vice president of emerging market investments at Caisse De Depot Et Placement Du Quebec.

"So, yes, we are exerting a lot of pressure on the GPs. I won't say too high, but very high."

The scrutiny from institutional investors is especially acute in Asia, where private equity returns have failed to meet the expectations of pensions and endowments.

After a steady climb from 2003 onward, Asia private equity investors have faced a volatile market starting in late 2008, which saw a quick recovery, and then a steady decline since early this year.

That has led some private equity firms to encounter, for the first time, difficulties in raising money in Asia, where a bifurcation has emerged between managers making money, and managers struggling. LPs are thus cautious in putting money into a region they once widely allocated to.

"We will back managers who are specialists, covering a sector that is quite large, like the overall TMT (tech-media-telecom) sector in the US, or financial services because they are a huge sector and they have a lot of subsectors," said Fortier, of the Canadian pension fund.

Joseph Skrzynski, founding partner of Australia-based Champ Private Equity, finds LPs too focused on a perfect track-record, failing to recognize the inherent ups and downs that come from a market such as Asia.

Champ was fortunate to raise money ahead of the current crowded period, he said.

"Volatility comes with private equity," Skrzynski said on the same panel that Bonderman spoke on.

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