What does that mean for private equity?
The industry has never been as popular as it is today. The appetite from the investor community driven by the unique performance delivered over time enabled funds to successfully fundraise unmatched level of capital while asset under management is breaking record year after years.
Nevertheless, the market might enter a new era. The abundance of “dry powder” triggered significant competition for quality assets in certain regions and led to record high valuation levels for private assets, currently even above the valuation levels of public assets.
On the other hand, many small and medium enterprises have piled up high level of debt – for which interest rates may rise, being left with no other choice than passing inflation to their customers to keep an acceptable level of margin.
In this context – and more than ever - the ability for private equity funds to create operational value will be crucial to sustain a double digit return over the next decade. Concretely, this means focusing on identifying and selecting companies with significant moat and spend time helping executive committees to make the right strategic move. Private Equity has proven to be successful in the past and will need to show its resilience once again if the context gets confirmed. What else can Private Equity funds do to remain successful?
Seizing new opportunities
Beyond the required focus on “creating operational value”, two other drivers may influence the ability of the industry to leverage the current environment:
First is the expansion of the distribution to the wealth management segment. This segment is nascent in Europe as the distribution has been restricted to professional investors only. With barely a 1% to 2% allocation to alternatives in a global retail market worth about $80 trillion, the opportunity for asset managers is significant. The European Union has now clearly opened the door from a regulatory perspective: the revised version of the European Long-Term Investment Fund (ELTIF) will allow such distribution to become seamless across Europe. A windfall for alternative asset managers that will adapt their distribution network and equip themselves with the right technology to absorb the operational constraints triggered by such investor profile. The race to amass market share is likely to accelerate from here.
Second is the measurement of the extra financial return generated by the industry. Recent regulatory development in Europe including the Sustainable Finance Disclosure Regulation (SFDR) and overall awareness in the investors’ community over environmental, social and governance has placed the topic quite high on due-diligence questionnaires of large institutional investors and start to be a deal breaker if these criteria are not met. While the actual measurement of these indicators is cumbersome and may be costly at first sight, the ability to provide reliable and consistent information around the extra financial performance of the funds may make a difference between two managers investing in the same asset class and performing the same.
How can Luxembourg stay ahead of the game?
Since the last two decades, Luxembourg has built an uncontestable track record as a prominent fund center for Private Equity. In a changing world and an increasingly competitive environment, three factors seem critical:
Attracting and retaining talent:
As talent war affects all economies, it is essential for the country to keep attracting newcomers and educate the existing workforce to the evolving complexity of the industry. Our central position as a pan-European distribution hub may also foster the development of new functions beyond the traditional middle and back-office functions already implemented. This includes fundraising and investor relations, which appear to be a wise next step for the industry.
Innovate on what matters:
The regulatory changes are since long now driven by the European Union. To remain ahead of these changes and reaffirm our deep grasp of the industry, Luxembourg needs to continue to lead the way in terms of legal innovation and regulatory boldness. Active collaboration between all the stakeholders will be essential to continue to innovate in the common interest.
Leverage the growth of alternative investment distribution to wealth management:
As the traction for distribution of alternative products to retail investors kicks-off, the Luxembourg wealth management ecosystem has a fantastic role to play. The success will come from two angles: the ability to include Private Equity products in their offering and relevant investments to tackle the operational complexity that comes with such distribution.
