Wall Street bonuses on par with the glory days of the early 2000s have convinced many investors (and politicians) that the financial sectors is back on steady ground, churning out record profits and once again rolling the dice on risky financial instruments. But according to a recent study, private equity firms face one of the toughest operating environments in decades, and a wave of mergers and closures is expected to wash over the industry in coming months.
A poll conducted by the Private Equity News, more than 80% of private equity managers expect “a wave of closures or mergers within the industry because the poor fundraising environment will last longer than previously expected,” writes Tom Fairless. Of the 500 people and firms surveyed for the poll, three quarters of those expecting industry consolidation believe it will come in the form of fund closures due to inability to raise funds, while the other quarter expect M&A activity to drive consolidation. Takeovers within the private equity industry are a relatively rare occurrence, but the prolonged weakness in fundraising markets many have encountered is unprecedented, and threatens to change the face of the industry.
Private Equity ETF
Exposure to private equity investments through a publicly-traded ETF may seem like an unlikely combination, but that’s exactly what the PowerShares Global Listed Private Equity Portfolio (PSP) offers. This ETF invests in 60 private equity firms around the world, including business development companies and financial institutions whose principal business is to invest in and lend capital to privately-held companies. Because private equity firms generally maintain a portfolio of various investments, the number of companies to which PSP offers indirect exposure far exceeds 60.
PSP gives its largest country weighting to the U.S. (36%), but also offers exposure to private equity firms in the UK, Sweden, France, and the Netherlands. Among PSP’s holdings, well-known U.S. firms Blackstone and Apollo Investment maintain significant weightings. With a dividend yield of almost 7%, PSP is a potentially-attractive option for investors focused on generating current returns.
Time To Buy?
Private equity investments delivered big gains in 2009 as the market recovered following the economic downturn. PSP gained nearly 140% between the bear market lows in March and the end of the year, as the return of credit to financial markets increased opportunities for firms bogged down with debt and illiquid investments. Still, PSP remains nearly 50% below pre-recession levels.
Sentiment within the private equity industry is clearly yet to fully recover, as firms expecting to trim their operations far outnumber those expecting to expand significantly in the short term. Data provide Pequin reported that the fourth quarter of 2009 was the worst fundraising quarter in more than six years for the industry, and many don’t expect significant improvements any time soon.
The companies held by PSP are obviously publicly-held, a trait some have argued diminishes their status as true private equity firms. But in the current environment, these companies have one very significant advantage over their closely-held competitors: access to public equity markets as a source of financing. If the doom-and-gloom predictions from the industry prove to be accurate, there could be dozens of private equity firms looking to liquidate part or all of their portfolios in order to survive in the post-recession environment.
In a buyers’ market, those with sufficient cash on hand (or relatively cheap access to capital) are inevitably presented with plenty of opportunities. If the private equity industry is indeed headed for a major shakeup, PSP seems to be well positioned to take advantage.
Disclosure: No positions at time of writing.