September 18, 2012
Interviewed by: David Snow
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Decline of PE Was “Massive Exaggeration”

The glass is half-full for Peter Cornelius, Chief Economist for AlpInvest, an affiliate of The Carlyle Group and one of the world’s largest private equity programs. Cornelius concludes that, in spite of challenges, the world’s asset class has “room for attractive investment opportunities.”

In an interview with Privcap, Cornelius analyzes the European private equity scene and notes that dire predictions about the private equity failure rate have proven to be “massive exaggerations.”

This program is sponsored by and was produced at the annual conference of SECA, the Swiss Private Equity & Corporate Finance Association.

The glass is half-full for Peter Cornelius, Chief Economist for AlpInvest, an affiliate of The Carlyle Group and one of the world’s largest private equity programs. Cornelius concludes that, in spite of challenges, the world’s asset class has “room for attractive investment opportunities.”

In an interview with Privcap, Cornelius analyzes the European private equity scene and notes that dire predictions about the private equity failure rate have proven to be “massive exaggerations.”

This program is sponsored by and was produced at the annual conference of SECA, the Swiss Private Equity & Corporate Finance Association.

Privcap: How does Europe’s economy look from a private equity standpoint?

Peter Cornelius, AlpInvest: From a private equity standpoint, I think it’s important to recognize that Europe is far from being homogeneous. There are a number of economies the highly competitive, in particular, in the core, in Scandinavia, the UK. And then, of course, we have countries in the periphery that lack competitiveness. With that set, in those countries, important adjustment measures and structural reforms are under way.

So from a private equity standpoint, I think we need to recognize that entry prices have declined very significantly, which gives room for other attractive investment opportunities. There is a significant amount of macro risk and that needs to be managed very carefully. But those investors who are able to identify those investment opportunities look set to generate very attractive returns for their investors.

Privcap: Private equity deals are up slightly across Europe.  Do you expect that trend to accelerate? 

Cornelius: I would expect deal activity to continue to rise. And it’s not really that deal activity has fallen off the cliff. When you take a longer term view, then Europe accounts for about one third of global deal activity in buyouts. It has always been less in venture capital. But as far as buyouts are concerned, Europe has accounted for about one third. We’re a little bit below that. But given the reform process that is going on right now, I would assume that over the medium term, Europe will be able to catch up again.

Privcap: Please discuss the breadth of information that you can analyze with in your portfolio.

Cornelius: We currently have about 7,000 portfolio companies in our portfolio. And we monitor very closely the individual portfolio companies, in particular the larger ones, which is an important factor in assessing the macroeconomic environment. So what’s going on in individual portfolio companies across different countries and across different sectors gives us very granulated information about the macroeconomic picture.

Privcap: What is a key risk that that financial crisis highlighted for LPs?

Cornelius: What has brought a number of limited partners, in particular those with significant allocations to illiquid asset classes, into trouble was actually liquidity risk. The unfunded commitments that forced them to liquidate part of their liquid portfolios. And this resulted then in rather significant losses.

So I think one needs to take a holistic approach when talking about risk management from an LP’s perspective. Yes, it’s market risk. It’s capital risk, in the sense that funds might not be returning the capital. But it’s, to a large extent, also liquidity risk.

Now I’m sharing a working group for the European Venture Capital and Private Equity Association. And this is working group has been created in the aftermath of the global financial crisis in order to develop guidelines that might help limited partners develop a risk framework.

Privcap: How do you think the tough fundraising market will affect private equity?

Cornelius: Well I guess right now the fundraising market has remained rather shallow, which is not untypical. The private equity industry is going through different cycles. This is not the first one. We had one in the early 1990s after the US recession. We had a down cycle after the tech bubble in 2001, 2002, and it took two or three years before fundraising started to recover.

What we’re seeing right now is bottoming out off the fundraising cycle. When we look at this from a quarterly perspective, we now see early evidence that a recovery might be expected in the second half of the year and into 2013. But of course, given the very high amount of macroeconomic uncertainty and given the situation in the credit markets, it remains to be seen whether the early signs of a recovery can actually be sustained.

Privcap: We have recently seen a number of private equity firms cut staff. Should the market expect more of this downsizing?

Cornelius: Very difficult to say, but what I would say is that this is not usual at all. As I said, the private equity industry is a cyclical industry and you would expect adjustments as the cycle gathers momentum. One could even argue that given the very sharp adjustment in fundraising and the deal activity, cost cutting would have been substantially more brutal.

And in fact, recall, I think it was in the fall of 2008, several studies were published anticipating a collapse of large private equity firms in the range of 40% to 50%. And in terms of portfolio companies, the expectation was at that time that 40% to 50% would default on their debt. Now four years later, I think we can say that this was a massive exaggeration. Of course there is some adjustment going on, and it might continue depending on what’s going on in the broader economy, but it’s nowhere near what had been expected at that time.

Privcap: What keeps you optimistic about the future of global private equity?

Cornelius: I think the most important advantage of private equity, clearly, is that it’s a superior governance model. From an investor’s standpoint, from a limited partner’s standpoint, what counts is a performance of the asset class. I think we have now ample evidence that even net of fees, private equity has outperformed public equity by a fairly significant margin. So given the attractiveness of the asset class from an investor’s standpoint, I’m quite optimistic that private equity will continue to grow.

Over the past 25 to 30 years, we have seen an increase in buyouts or assets under management of buyout firms from $2 billion in 1980 to about $1.3 trillion in 2010. That is a compounded annual growth rate of more than 24%. The trajectory might become a little bit flatter as we go forward, but I’m very optimistic that private equity will remain a very effective asset class for institution investors.

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