Recent conversations between BHA analysts and investors in the United Arab Emirates indicate that the flow of capital into private equity and real estate funds from many of the region’s investors will decrease during 2010. Alternately, these investors will focus on more liquid public investments or on direct investments in companies and property.

These observations have emerged from interviews with investment officers of family offices, wealth advisors, and banks in the UAE. For example, a bank in Abu Dhabi that has committed more than $1 billion to single- and multi-manager private equity funds in the past has said that it is fully allocated to these asset classes until 2012. Separately, a family office in Dubai that has traditionally invested in both private equity and real estate funds told BHA that it will not be making any fund investments in these funds until at least 2011. The firm said that if its clients want to increase their exposure to private equity and real estate, it has the expertise to source direct deals.

It is not only private investors that may limit their investments in private equity and real estate funds. An investment officer at a large government investment house commented that he believes that most government pension funds in Abu Dhabi and Dubai are almost out of capital to place into long-term investment funds. He anticipates those that do have capital will invest directly rather than through funds in order to avoid management fees and provide more one-off deals for clients.

In an environment where investors remain concerned about liquidity as well as market instability, fund managers should be mindful of their approach to investors. Many investors, such as those in Abu Dhabi and Dubai, are still feeling the effects of the credit crunch. Additionally, Abu Dhabi is dealing with the bailout of Dubai World, which has affected the local economy. Fund managers looking to create relationships with investors in this region should understand that it will be a lengthy process to regain the confidence and commitments of the UAE’s family offices, wealth advisors, banks, and government pensions.

Historically, private equity has been the leading source of capital to businesses as the U.S. economy recovers from recessions. According to the Private Equity Council, “Following the past five periods of negative economic growth in the U.S. (1974, 1975, 1980, 1982 and 1991), real private equity investment increased by an average of 94 percent during the initial year of recovery.”1 In addition, “The number of private equity acquisitions grew by an average of 55.1 percent in each of the five years following an annual decline in GDP.”2

According to BHA’s research, this pattern is evident in the current recovery. Comparing the number of private equity mandates for the first quarter of 2009 with the number for the first quarter of 2010, analysts saw an increase of roughly 15 percent.

More interesting than the increase in the number of mandates, however, is the significant interest in small- and mid-market funds. Looking at year-over-year statistics, in the first quarter of 2009, roughly 50 percent of investors BHA interviewed expressed interest in large-market funds. One year later, that number dropped to less than 40 percent. At the same time, more than 95 percent of investors expressed interest in mid-market funds and 70 percent voiced an interest in small-market funds.

Furthermore, less than 15 percent of the investors BHA analysts have spoken with this year have shown an interest in private equity funds raising more than $500 million. Conversely, more than 40 percent are looking for funds with $200 million to $500 million in assets, and 25 percent are seeking funds with less than $200 million under management.

It is not surprising that investors are flocking to small- and mid-market private equity funds since they have outperformed their large-market counterparts in the last year. What is surprising is that large-market funds have not adapted to the current trend.

A recent discussion with an analyst at an international fund of funds shed light on the situation. This analyst noted that after years of focusing on mega-size transactions, large-market funds lack the mid-market network and reputation necessary to complete smaller-sized deals. If the larger funds want to compete, they will have to significantly scale down operations and shrink fund size.

However, even after putting the proper infrastructure in place and changing their fundraising model, large funds may not find it easy to attract investors. BHA has received more than 400 private equity mandates since January 1, 2010, and more than 99 percent of investors told analysts that they either require or prefer experienced managers. Of these investors, only 30 percent would consider a first-time team and 60 percent would look at a spin-off.

Experience is paramount for investors when selecting a private equity manager, and that is not acquired quickly. While large funds are considering their options or trying to shift strategies, it appears that smaller, more nimble funds will capture more investment dollars.

1,2 Private Equity Council, “Summary of research findings,” May 11, 2010.

Asia has been the focus of many hedge fund investors’ searches during the past year. Now it seems to be topping the list of many private equity investors as well.

During the past quarter, BHA analysts have noticed increasing interest in Asia-focused funds of private equity funds. Much of this interest comes from pension funds and insurance companies. In fact, these two investor categories accounted for more than half of BHA’s fund of private equity fund mandates during the past month.

Many of these investors are looking to make their first investment in the region. A Swedish-based pension fund has determined that its current portfolio is underweight in this region. Because this is its first foray into Asia, however, it is researching funds of private equity funds. The firm believes this fund structure will help it gain exposure to the region more easily and efficiently than if it were to research and select individual managers and funds.

Taking the multi-manager route seems to be a common approach. A large insurance company based in the Netherlands that is also looking to invest in the region is evaluating funds of funds. It is interested in diversifying its portfolio across many private equity strategies, and it wants to be able to rely on established managers with an expertise in the region to select the right funds.

Apparently, BHA analysts are not the only ones who have spotted the growing interest in Asia among private equity investors. According to the Financial Times, “More money is set to pour into private equity in emerging markets, as investors increase their commitments to funds targeting deals in China, India and Brazil.”1 In fact, the Emerging Markets Private Equity Association expects the proportion of total private equity commitments going towards emerging markets will double to 11 to 15 percent in two years.2

BHA expects Asia-focused funds of private equity funds to stay on investors’ radar screens for some time. Given the growth in the region and the many funds of funds with expertise in the market investors will want to take advantage of this opportunity.

1,2 Financial Times, “Investors set to double private equity bets in emerging markets,” April 19,2010.

On a daily basis, BHA research analysts hear from a variety of investors that are striving to find quality, blue-chip managers that operate core alternative investment strategies. Such strategies include long-short equity, global macro, and credit in the hedge fund space, as well as buyout, venture capital, and distressed in the private equity space. However, every so often an investor mentions a unique, niche interest that is outside the box.

This was the case recently. During an in-depth conversation with a portfolio strategist at a large wealth advisory firm, a BHA analyst learned of his and the firm’s interest in entirely green venture-capital funds that focus on alternative forms of clean energy and clean technology. More specifically, he and the firm are interested in solar power and solar technology. But their niche interest is desalination.

What makes this mandate even more intriguing is that the investor is interested in green funds and opportunities that will directly benefit the military community and military families. Because this search is so focused and unique, the firm is willing to consider new management teams as well as more experienced ones. It is also flexible in regards to funds’ target size.

Many experts believe that within the next 50 years, there will be a great shortage of drinkable, fresh water. As a result, there has been growing interest in finding alternative methods to produce and provide Earth’s various populations with fresh drinking water.

Investors that are interested in or aware of this effort have realized that it is a long-term investment opportunity; it could be years before research and development endeavors come to fruition. Nevertheless, investors will not wait to seek out relevant fund managers or make direct investments in venture capital funds to take advantage of these opportunities.

It is important to note that this particular firm has a history of focusing on unique opportunities. The firm originated as an insurance provider for military officers who were unable to acquire insurance coverage because they were seen as too high of a risk. Throughout the past 90 years, the firm has grown and expanded into a multifaceted financial services firm, however, it has never strayed from its roots: catering to the military community and its families. It intends to continue to do so, even though today the firm is striving to create a corporate culture that is much more energy conscious and retool its infrastructure and operations to be energy efficient and green.

Investors and fund managers alike want to be aware of the general tendencies of investors in core, mainstream areas of the alternative investment space. However, learning of investors’ niche and unique interests is equally important and insightful, as they can shed light on new and emerging areas of focus. They also prove that the industry will always grow and morph as investors’ interests mature and change with the times. As new interests arise, so, too, will new, specialized funds that offer investors untapped opportunities to profit from.

When it comes to clean technology investing, North American investors have been the front runners. In 2009, however, it was European investors’ support for this sector that gave it a significant boost. According to market researchers Cleantech Group and Deloitte, European venture-capital investment in clean tech declined by only 12 percent in 2009 as opposed to 42 percent for North American investment.1

A major market that is playing an important role in the continuing stability of the sector is Germany. BHA analysts have noticed increased interest from German investors in clean tech. During recent conversations, these investors have expressed that they want to invest in the sector not only because it offers attractive returns but also because it is a socially responsible investment.

Additionally, German investors are looking at multiple ways to enter the market. Although many are considering venture capital funds, others are evaluating long-only funds offered by hedge funds.

A German fund of private equity funds launched a fund dedicated to clean technology. The firm said it started the fund because of the attractive opportunities as well as the amount of investor interest. The firm has capital and is ready to make opportunistic allocations.

A German private bank, on the other hand, is interested in long-only funds focused in the clean technology sector. The bank told BHA analysts that many German investors are interested in the space. Therefore, it launched a clean tech fund of funds in order to give more investors an opportunity to gain access to this sector.

BHA analysts expect investors will continue to have an interest in the clean tech sector since it is being backed by governments across the globe. If these investments are profitable as well as environmentally ethical, it is a sector that investors will continue to add to their portfolios.

1 EurActiv Network, “Europe catches up on clean tech venture investment,” January 12, 2010.

The recent economic turmoil brought with it a host of difficulties for small and mid-market companies. Chief among these challenges was access to capital. Companies found it hard—and sometimes impossible—to secure bank loans for expansion or restructuring.

Despite the improving economy, many companies are still hard-pressed to find funding and therefore are seeking mezzanine financing to fill the gap. From Florida to Wales, private equity funds are surfacing to address this demand. 1, 2

Many see private equity’s help as key to the future. Bill McCollumn, Florida’s Attorney General, recently stated that mezzanine funding “can play a crucial role in helping the state’s young companies grow and diversify the state’s economy.” Others see such funding as a way to create jobs in an economy that is in dire need of additional employment opportunities.

Institutional investors that have not had exposure to the mezzanine space see opportunity in private equity’s funding of small- and mid-market businesses. Comparing data from the first quarter with results from the fourth quarter, BHA saw an increase of more than 50 percent in the number of investors interested in mezzanine funds.

One of the main players in this expanding market is government pension plans. Public pensions have always been significant players in private equity buyout funds, but now they are moving into the mezzanine space as well. This month, more than 40 percent of investors interested in mezzanine funds were government pensions.

The mixture of debt and equity that usually comprises mezzanine investments is attractive to pensions because, as the Minnesota Center for Public Finance Research notes, the steady interest payments from the debt component act as a hedge against risk while the equity portion allows for further gains from company growth.3

Many pension plans’ requirements for managers’ track records, assets under management, and fund size varied. However, one specification was almost completely consistent across the board: more than 90 percent of investors were interested in small- and mid-market-focused funds. Apparently, investors are aware of the opportunities that can be found in this space, where traditional bank loans are no longer the standard avenue for access to new capital.

1 WalesOnline, “Call for funding to fill gap welcomed by Government,” November 24, 2009.

2 South Florida Business Journal, “South Florida companies benefit from new $450M mezz fund,” March 11, 2010.

3 Minnesota Center for Public Finance Research, “Public Pensions in Minnesota: Re-Definable Benefits and Under-Reported Performance, May 2006.

During the past two weeks, BHA gathered more than $40 million in mandates from Japanese investors looking for private equity funds focusing on distressed opportunities. Two large corporate pension funds are among those investors looking to make new commitments to this strategy during 2010. Each is seeking one or more funds focusing on the U.S. or other developed markets. Additional mandates came from a Japanese insurance company as well as a fund of private equity funds that also want to capitalize on distressed opportunities in the U.S.

While distressed opportunities within the private equity space have been in high demand over the past few quarters, it is interesting to see such a high demand from Japanese institutional investors, and especially corporate pension funds.

Japan’s corporate pension funds experienced significant losses for the fiscal year that ended March 2009, as its economy officially entered a recession in October 2008. Throughout 2009, mandates for private equity funds from Japanese pension funds were few and far between. BHA learned through its discussions with these investors that many were waiting for signs of stability in their economy before entering into new commitments, whether in domestic or international markets. As their 2009-2010 fiscal year came to an end on March 31, the rate of return on their current investments reached approximately 13.8 percent.

Based on BHA’s recent conversations with these investors, it appears as though this rate of return gave them a sense that economic stability is starting to settle in. As a result, they have started to join U.S., European, and neighboring Asian-based investors that believe that the distressed private equity market in the U.S. is favorable, both for turnarounds and for distressed-for-control situations.

It is also important to note that about 75 percent of these investors are looking for experienced management teams that are targeting a fund capacity of more than $500 million. The investors have no deadline on making new commitments, but the capital is on hand to allocate. Providing they find qualified and compelling funds, commitments should take place by mid-year.

The time in between private equity fundraising cycles is a crucial period for managers—it is a time when managers should maintain an ongoing dialog with investors. This is important for several reasons. First, conversations with investors are how relationships are built. Second, the knowledge and understanding of investor and industry trends gleaned during these discussions will go a long way when it comes time to develop a strategy and raise funds. Finally, investor commitments do not happen overnight.

In an industry with a long-term investment cycle, relationships between private equity fund managers and investors are critical. Managers looking to raise funds cannot approach a new investor and expect to receive a commitment within a few months. The dialog needs to start much earlier and then develop over time as the manager communicates with the investor without the pressure of selling.

Frequent contact provides an opportunity for a manager to learn about an investor’s background, investment style and philosophy, and current outlook on the market. It is also a chance for a manager to discuss the firm and its background and investment strategy. When private equity funds are fundraising, they must focus on selling their products; they don’t have time to have in-depth, exploratory conversations with organizations to see which ones are potential investors. Rather, in between fundraising efforts is the time for managers to learn about investors and have honest conversations without any expectations of what might come in the future.

Maintaining an ongoing dialog with investors also allows managers to stay on top of what is happening in the market and outside of their current investment universe. By speaking with investors, managers come to understand trends in the market. They learn the types of strategies investors are allocating to, and the qualities of the fund management team or infrastructure that are most important to investors. Fund managers that are in touch with investors know which organizations are most likely to take an interest in their investment strategy.

Investors’ commitments do not come within a few months of the first meeting but after several months—maybe even years—of conversations. Managers that are frequently speaking with investors have contacts and established relationships even without a product to market. When the firm begins to plan its strategy for the next fund, it is ahead of the game because now it is re-connecting with people who already know them as opposed to starting from scratch.

Global markets posted strong gains in the latter half of 2009 and investors returned to the alternative investment arena. Although significant opportunities existed for private equity investors in the developed markets of the U.S. and Western Europe, many looked to funds focused on China and Asia.

In the third quarter, BHA analysts noted that 8.5 percent of private equity mandates were for China-focused funds. In the same time frame, Asia-focused funds made up 23.3 percent. In the fourth quarter, 9.2 percent of active private equity investors expressed interest in evaluating funds focused on China, while almost 21 percent indicated a more general interest in some type of regional Asian exposure. Although combined demand for these funds changed less than .5 percent in the last quarter, individual demand changed more notably. Clearly, investors that were considering investing in Asia became more interested in China-specific funds.

This was not surprising considering the rallies in consumer demand and strong GDP predictions for the region, and specifically China. Highlighting China’s place in the international market, Hong Kong’s former central bank chief, Joseph Yam, insisted that in the wake of the struggling dollar and euro, the yuan should take its place as the “third pillar” of the global monetary system.1 An appreciating yuan, coupled with a depreciating dollar and euro, made direct investment in Asia and its biggest market, China, attractive for private equity fund investors.

Although it is possible that appreciation of the yuan will curtail international demand for Chinese exports, it is unlikely that the yuan’s value will gain so dramatically that importing goods from China will become unattractive. Even it if did, however, with nearly one-fifth of the world’s population, it is likely that the increase in domestic demand will far outweigh the decrease in international demand.

Given China’s growing influence in the world’s economy, it was no surprise that China-focused private equity funds were in high demand. However, many private equity investors—large institutions such as endowments, pension plans, and foundations—were not interested in country-focused funds with a higher risk profile than similarly focused regional funds. Thus, many investors seeking exposure to Chinese private equity focused on Asian funds which offer lower risk through investment diversification.

As BHA closed the books on 2009, analysts spotted another trend among alternative investors worldwide: 2010 was shaping up to be a big allocation year. That said, it is hard to imagine that funds focused on Asia, and specifically China, will diminish as we get a fresh start in 2010.

1 Bloomberg.com, “Yuan Can be ‘3rd Pillar’ of Finance System, Yam Says (Update 1),” December 18, 2009

Since 2009’s inception, investors have increasingly expressed interest in private equity funds focused on Asian countries. In the early part of 2009, investors were simply researching Asia-focused funds for future consideration. However, as the year has progressed, more and more investors have determined when and how much they will allocate to these funds.

One such firm, a private bank in Belgium, voiced its interest in Asia-focused private equity funds in early January. At the time, it stressed that it was only researching funds focused on this part of the globe and had yet to make any commitments. When a BHA analyst spoke with this same private bank in October, it was seriously targeting Asia-focused funds. Instead of its initial broad-based strategy search, the bank had narrowed its focus to midsize- and large-market buyout funds, and was planning to make allocations before the end of the first quarter of 2010.

The increased interest in Asia-focused private equity opportunities has been helped by the turnaround in the global economy. As 2009 progressed and the credit markets began to thaw, investor sentiment took a turn for the better. As investors gained confidence and the markets rebounded, the number of IPOs rose. On the stock exchanges of Hong Kong and Shenzhen alone, there have been 76 IPOs.1 This has caused private equity activity to increase as managers source deals and exploit opportunities within the marketplace.
As 2009 comes to an end and investors prepare themselves for 2010, Asia is likely to continue to be an investor target. According to IMF estimates, emerging Asia, which excludes developed economies such as Japan and Australia, is expected to grow by 7 percent in 2010.2 With many factors pushing Asia’s economic expansion forward, it can be expected that private equity investors will continue to dedicate both time and money to finding opportunities in this region next year.

1Asia Private Equity Review – Greater China Edition, “The Dragon Dance,” November 2009.
2 The Wall Street Journal, “IMF Raises Its Forecast for Growth Across Asia,” October 30, 2009.