June 2010

More than half of private equity investors have seen their annual net returns from the asset class fall to 10 per cent or less, as the financial crisis has taken its toll says an article in the Financial Times.

The financial crisis and prevalent economic conditions have hurt the performance of the private equity industry by undermining many of the big buy-outs that depend on large amounts of debt during the credit bubble. The crisis has seen the number of investors, making annual returns of ten percent of less, increase from about a fifth two years ago to just over half this year.

The article further states that two years ago, more than 40 per cent of investors had made more than 16 percent annual returns from private equity. This year only slightly more than 20 per cent of investors were able to make similar returns. Investors sitting on private equity portfolios have only achieved single-digit returns and are starting to question the strategies of their managers.

However, investors still seem to have faith in the asset class. A fifth still plan to raise their private equity allocation with just 13 per cent planning to scale back. Investors are also planning to increase their direct investment activity in the next three years. Such deals are expected to be focused on Asia-Pacific region.

Emerging markets will continue to attract a larger share of investors' wealth. The overhaul to investment strategies will happen in the light of lessons learnt from the downturn. There is light at the end of the tunnel and investors are already catching glimpses of it as the global economy gets back on track.

Source: Financial Times

'Controversial new rules for hedge fund and private equity fund managers operating in Europe are moving forward after winning the backing of European Union finance ministers' as per the Financial Times. There are still significant differences in the two sets of draft regulations, but meetings are expected to take place with the intention of resolving the issues before August 2010.

The two drafts of the directive agree on the following salient points:

· All managers of alternative investment pools including private equity will have to seek government authorization and ensure regular disclosure to investors and regulators.

· Larger funds will face regulatory oversight of their total borrowing.

· Fund managers will face restrictions on how they can be paid.

· There will be new protection for investors, including heightened responsibilities for depository banks that serve as custodians for fund assets.

Key issues still to be settled are:

· The conditions under which funds and managers based outside the EU can market to professional investors within the EU

· Whether EU-based professional investors will be able to invest in funds based outside the bloc which do not comply with the new rules

· Which fund managers get a so-called 'passport' to market their products anywhere within the EU provided they meet the standards to be agreed

· Whether remuneration rules will be guidelines or more detailed constraints; also whether there will be an exemption for private equity 'carried interest'

· The extent to which key decisions are left to be resolved unilaterally by the Commission after the directive has passed

The proposal backed by the EU finance ministers would allow national authorities to retain a say over 'third countries' i.e. the funds and managers based outside the EU. This would restrict the rights of such funds/managers to market their products in the EU. The debates that follow will close the gap and finalize the new rules applicable to alternative assets.

With GCC's hedge fund and private equity industry still in its infancy, the exact implication of such rules for this region cannot be predicted. However, tighter regulations and more transparency will certainly sit well with GCC investors.

Source: Financial Times

'In the world of luxury goods, the ocean-going motor yachts that fill the harbor at Monaco every summer have to be the ultimate symbol of lavish excess' says an article in the Financial Times. Private equity investors are still injecting fresh equity in luxury yacht brands and the most recent deal involved a £25m injection into Sunseeker, one of the best-known luxury yacht brands.

A closer look at the transaction makes it look more like a turnaround investment than a trophy deal; nevertheless the purchase was reminiscent of private equity deals at the peak of the credit bubble, when PE funds acquired prestigious yacht makers using large amounts of debt.

The co-founder of the private equity firm says he saw an attractive opportunity to help a market-leading company rebound from the crisis. There are other signs that private equity groups and other opportunistic investors are seeking to snap up luxury goods companies in anticipation that this notoriously cyclical industry will roar back to health as the recovery strengthens.

What will this mean for private equity firms who have burnt their fingers while buying assets in the luxury goods sector at the peak? There are opportunities in emerging markets for such brands especially as valuations do not fully reflect the potential. There have also been buyouts from Middle East firms in this space and more are expected from cash rich SWFs of the region.

Source: Financial Times

London's Mayfair hotel played host to 70 investors gathered for a chance to meet the UK and Ireland's 30 hottest technology start-ups says a Financial Times article. The UK and Ireland Tech Tour is a two-day speed-dating event that introduces young technology companies in need of money to potential investors.

Investors pay more than US$6,100 each for the chance to get to know these companies, which have been selected by a committee of venture capital investors. About 300 companies are whittled down to 30. The official agenda involves listening to 20-minutes pitches from each company, but the real courting is done during the breaks.

The Tech Tour has run more than 25 events since 1998, on a not-for-profit basis and focuses on different regions across Europe. The last time Tech Tour came to the UK was 2007, when venture capital groups were still flush with cash.

This time the profile of companies seeking investment was very different from 2007. Many are more mature businesses and already in profit, reflecting a growing reluctance among European investors to fund early-stage companies, where the risks are very high.

There is limited venture capital/ technology investment activity in the MENA region. Perhaps it’s time to launch a MENA chapter of Tech Tour but will fund managers in the region show any interest?

Source: Financial Times

'US Congress is considering removing certain tax perks that have helped inflate the private equity bubble' says The Economist. The legislation in question is the 'American Jobs and Closing Tax Loopholes Act of 2010' and the change is set to impact the treatment of 'carried interest'.

Currently, carried interest is taxed at the lower rate of capital gains (15%) as opposed to income (35%). The proposed bill will tax 75% of carried interest as income and 25% as capital gains, starting in 2013. The tax change is expected to add US$18 billion to the national exchequer over ten years and will affect mostly buy-out shops, venture capital firms, real-estate partnerships and some hedge funds.

Private equity industry giants are lobbying against the proposals but to no avail, as the House of Representatives has already passed legislation and the Senate is due to consider the same during June 2010. This is likely to impact the buy-out shops by discouraging young talent from going into private equity and driving buy-out firms to relocate to countries that offer more favorable tax regimes. Furthermore, listed partnerships might also become taxable from 2020. This could discourage future IPO’s and dent the share price of existing listed private equity firms.

The precise impact of this legislation will become apparent with time and will depend on whether it is adopted in other regions. For now the likely impact on the Middle East is negligible.

Source: The Economist – June 5^th 2010 (Finance and Economics)