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Appetite for U.S. mid-market, small-market funds will be strong in 2014, survey finds

A recent survey of limited partners has mixed news for general partners heading back to the well for fresh commitments in 2014, with many investors saying they have a strong appetite for U.S. buyout funds but little interest in evaluating new relationships with sponsors.

Nearly two-thirds of respondents (62 percent) said they “plan to focus most of our attention on investing” in U.S. middle-market buyout funds of $500 million to $2.5 billion in size in 2014, according to the survey, an annual poll conducted in October by placement agency Probitas Partners. (Respondents could pick up to five categories.) That is up from 49 percent of respondents who participated in the survey back in 2006, not long before the financial crisis hit. Interest in U.S. middle-market buyout funds was high among North American respondents, yet the sector still holds plenty of appeal for  European respondents (60 percent) and Asian respondents (52 percent).

In second place with investors came country-focused, middle-market buyout funds in Europe (a choice for 43 percent). That was followed by U.S. small-market buyout funds of less than $500 million (41 percent), growth capital funds (30 percent) and energy funds (26 percent), with interest in energy funds especially strong among North American respondents (40 percent).

Credit strategies have come into fashion (with 23 percent picking it as an area they planned to focus most of their attention on in 2014), while secondary funds (22 percent) and distressed debt funds (20 percent) hold significant appeal, the survey found. (Interestingly, distressed debt was the choice of 30 percent in the 2006 survey; best to keep an eye on that one.) By contrast, emerging markets excluding Asia (9 percent) have little attraction, as do U.S. venture capital funds, at just 15 percent. And the large and mega-funds that sopped of so much of the available capital raised in 2013? U.S. large buyout funds of $2.5 billion to $5 billion came in at 25 percent, while those of more than $5 billion came in at just 8 percent.

By geography, 92 percent of respondents picked North America when asked for their three major regional focuses in 2014, 85 percent chose Western Europe, and just under half (49 percent) picked Asia—down from 65 percent that picked Asia in the survey two years ago.

Altogether 137 senior investment professionals at public pensions (11 percent of respondents), corporate and private pensions (5 percent), endowments and foundations (6 percent), funds-of-funds managers (31 percent) and other categories of investors responded to the survey. About four in 10 (42 percent) have their headquarters in North America, a third (33 percent) in Western Europe, one in five (21 percent) in Asia and the Middle East and the balance in Australia.

The response of many of these limited partners to two key questions suggests they have relatively mature programs. That makes them a tough sell when it comes to forming new GP relationships. More than half of respondents (54 percent) said they expect their main focus in 2014 to be on “evaluating re-ups with current general partner relationships with a limited look at new relationships.” The same percentage responded that way in last year’s survey. Fewer than a third (28 percent)—again the same percentage as in last year’s survey—said they are “actively pursuing relationships with new managers.” In some encouraging news for fundraisers, the percentage of respondents looking to “significantly” reduce the number of GP relationships ticked down to 5 percent from 8 percent with the latest survey.

In a similar vein, nearly a third of respondents (31 percent) said they are roughly at their target allocations to private equity and “are looking to maintain that level of exposure.” Another 16 percent said they are under target and “actively committing” to funds to climb to their targets. Both percentages are roughly in line with those from last year’s survey. More than a third (37 percent) of respondents said they were managers of funds of funds to whom the question didn’t apply.

Both the secondary market and co-investment markets continue to show strength, the survey found. Nearly half of respondents (45 percent) said they “actively” purchase limited partnership interests on the secondary market, while nearly a third (31 percent) said they had sold or are considering selling interests “for portfolio management purposes.” The latter percentage is the highest ever found by Probitas Partners. Meantime, more than a third (35 percent) of respondents said they have an “active internal” co-investment program, a figure that rises to 59 percent for large investors that plan to commit $500 million or more to private equity in 2014.

And what factors will lie behind fund selection in 2014? Interestingly, asked what will drive their sector focus in 2014, nearly half of respondents (47 percent) said “my institution simply pursues the best funds and managers available in the market.” That was by far the most popular choice. Just one in 10 (12 percent) said that they focus on those sectors they believe “will outperform others in this vintage year.” And just 7 percent answered “targeting funds that will provide access to co-investments.”