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Global private equity watch 2011 - Strategy has never been more critical - EY - Global

Global private equity watch 2011

Strategy has never been more critical

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Private equity fund-raising 2005-2010

Private equity fund-raising 2005-2010

Source: Preqin. Includes all investment styles except venture and venture-related, including but not limited to: buyouts, real estate, infrastructure,distressed, fund-of-funds, secondary funds, balanced funds, and mezzanine. Funds listed by date of final close.

To remain competitive, PE firms will need to do everything they can to drive outsized returns.

More than ever, PE firms now need to determine the shape and size of their firms. This is a significant year for PE. Those who get it right — define a clear strategy, deploy capital effectively against that strategy and continue to innovate — will win. Those who deploy capital indiscriminately against a ticking investment period, in a pricey market could face steep challenges.

Globalization and winning in the emerging markets

The largest firms continue to diversify geographically, with increased presence in both the developed and developing (emerging) markets. While the US began its rebound in 2010, activity in EMEA looked to be six months behind. As was clearly demonstrated in this most recent downturn, the emerging markets suffered less and recovered more quickly than developed markets. Exposure to the emerging markets can mean a more balanced portfolio — and one that can better withstand another downturn.

However, this effort comes with increased country-specific risk as history has demonstrated. Many of the large firms are actively investing in geographic expansion, opening offices in key markets around the world, deploying professionals from home offices and hiring local experts who know the markets and can access the best deals.

Private equity fund-raising

Private equity fund-raising 2005-2010

PEs are diversifying into new business lines

While the LBO model remains at the core of the PE asset class, for the largest firms, maturity has resulted in evolution. In 2010 some of the mega global PE firms began to diversify — entering new lines of business through both organic growth and strategic acquisitions — as they actively work to evolve their business models beyond traditional buyouts.

These firms are actively expanding into business lines traditionally occupied by the investment banking and asset management industries, increasing their capabilities in a range of activities including advisory, capital markets, asset management and leveraged finance. This trend is likely to accelerate in the next year or two as regulatory initiatives in the US press many banks to divest major business units.

The recent acquisition by KKR of a team from Goldman Sachs' proprietary trading operations underscores the opportunity that PE firms are now seeing in terms of access to previously unavailable talent. Time will tell if this trend of morphing into broad asset management firms continues to shape the industry. Currently, it is the domain of the largest US domiciled funds.

Raising capital

Many PEs are also considering accessing public markets and raising capital through the IPOs of the PE firms' management companies. Permanent capital has allowed firms to expand into new lines of business and, to a certain extent, reduce the dependency of the firm on limited partners and perpetual fund-raising.

To date, Fortress Group, 3i Group, The Blackstone Group, KKR and Apollo are public. Several others, with an eye towards succession planning and providing ownership equity to professionals and permanent capital for the firm, have filed their intentions.

What will happen to the middle market?

Facing increased competition for capital, smaller and mid-market funds will need to find ways to differentiate and stand out in the crowd. They may focus on a niche investment strategy — either by size of business, distressed assets or focus industry. To remain in the coveted top quartile, these funds will need to do everything they can to drive outsized returns.

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