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Private equity inspires polarised views. Its spectacular performance over the past three to five years is viewed by some as an accounting "trick" that has been exposed by the current credit crisis and by others as evidence of an industry that adds substantial long-term value through clever management of assets.
Michael Gordon, global head of institutional investment at Fidelity International, has left no one in any doubt over his views. Writing in the Financial Times last month, Gordon said: "So now we know. The boom in private equity, which was promoted as the superior business model, based on patient capital, superior management and an alignment of interests, was nothing more than a trick of financial engineering - and a clumsy one at that. The magic of leverage works both ways, as we are discovering."
While Gordon has his supporters, others wonder if it is reasonable to write off an entire industry. After all, the most successful exponents of the leveraged buyout were producing significant returns long before credit conditions became as relaxed as they were in early 2007.
John Gripton, head of European investment at Capital Dynamics, a Swiss-based group running $20 billion-plus (Dh73.56 billion-plus) in funds of private equity funds, says: "In the early 1990s, restructuring and financial engineering may have dominated, but this model was not sustainable and has changed.
"We invest only in funds that create value by improving the performance of the portfolio companies. If we are to invest, then general partners must look at improving sales and Ebitda [earnings before interest, taxes, depreciation and amortisation] growth together with operational improvements."
We'll be back
The British Private Equity and Venture Capital Association is more robust in its response to criticism of the sector. Simon Walker, chief executive of BVCA, says: "Institutional investors ... have chosen to invest in private equity - rather than in firms like Fidelity - because they have seen how the best-performing private equity firms have outperformed the market. In future, debt is going to be harder to raise - but that won't stop investment in buyouts."
While the cheerleaders for private equity argue that negative perceptions of the industry are wrong, they do concede that investors' expectations have to change.
Gripton says the 30-40 per cent returns achieved by some funds in recent years will return to the long-term average of about 15 per cent. "The last three to four years should be seen as a bonus in terms of returns," says Gripton.
"We have been telling clients that returns will come down but will still remain attractive compared to other asset classes."
The message is less applicable to long-standing investors - who have experienced several economic cycles - than to new investors who have been drawn in by mouth-watering returns and expect them to continue indefinitely.
Capital Dynamics allocates resources to educate this group, who are the most likely to become disillusioned and retreat from the market if returns decline.
This was the case in the 1980s, Gripton says. "Private equity got off to a poor start in Europe in the 1980s because returns failed to match performance in the US market. Many investors withdrew and it has taken a while to get them back in."
But, so far, there is no sign of reduced investor interest, according to Capital Dynamics. Even the disappearance of the "mega-deals" that set investors' pulses racing has not dented confidence.
Gripton says: "Mega-deals are not a big part of the private equity universe - they only tend to get done on an opportunistic basis. If they dry up, there will be no over-hang of capital because two or three large buy-outs will get done instead."
There is, however, likely to be a "quiet period" ahead.
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