Institutional investors allocate more money to private equity amid volatility in public markets

Institutional investors plan to keep putting capital into private equity, despite rising prices for new acquisitions, to beat the returns from public markets facing significant headwinds from inflation and the Ukraine war, according to a study by law firm Torys LLP.

After a record-setting round of private equity deal-making in 2021, Torys surveyed 52 of Canada’s largest asset managers and private-equity funds. The study found 90 per cent of institutions said private-equity valuations on acquisitions are now either slightly or very overvalued.

The majority of these large investors, including pension plans, said current owners of businesses now have lofty expectations of what their company will fetch when put up for sale. “These indicators point to a frothy deal market,” Torys said.

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However, Torys partner Guy Berman said in an interview the outlook for private equity remains upbeat, with the majority of investors expecting future performance to match or exceed historic returns. “Private equity now has a 30-year track record for strong performance,” Mr. Berman said. “When performance from public markets is expected to be weak, that shapes investment decisions.”

Owning a few, high-quality business in a private-equity fund can eliminate the risks that come from holding a broad selection of companies in a public-market portfolio. In recent months, benchmark indexes such as the S&P 500 have sold off sharply because of geopolitical concerns, dragging down returns.

Last year, Canadian private-equity and venture-capital funds set records by investing $14.7-billion across 752 deals, more than double the previous high-water mark set in 2019, when fund managers put $6.2-billion to work in 539 transactions, according to data from the Canadian Venture Capital & Private Equity Association.

The Torys survey found most private equity managers expect raising new funds will be more difficult than in the past, owing to “world events and other factors, including the prospect of rising interest rates.” The study said: “In particular, recent events related to the Russia-Ukraine conflict as well as sanctions on Russia, may have broad global implications.”

Private-equity fund managers plan to increase their investments in technology businesses, with 63 per cent of institutions predicting the sector will see the most takeover activity this year, up from 55 per cent of respondents last year, according to the study.

“As businesses continue to focus on digital transformation, the technology sector remains a key sector of choice for private-equity deal-making,” Torys said.

The survey showed private-equity funds are focusing on the intersection of financial services and technology as a major investment theme. The study said deal activity was particularly strong in asset management, payments fintech, insurance, banks, loyalty partnerships, and international bancassurance. Bancassurance refers to sales partnerships between banks and insurance companies.

In contrast, institutional investors predicted a decline in investments in entertainment, industrial and agricultural businesses compared with last year.

As the private-equity industry matures, institutional investors are increasingly open to owning businesses for longer than the traditional 10-year commitment of an investment, using approaches such as continuation funds. This approach, first seen in Canada about two years ago, sees existing investors offered the chance to cash out of a business or continue to own it in the new funds.

The Torys survey found over the past year, 58 per cent of institutions have considered or participated in an continuation fund, compared with just 43 per cent of respondents in 2020.

Mr. Berman said institutional investors are keen on opportunities to maintain or increase their stakes in high-quality businesses through continuation funds and co-investments. They are particularly keen on co-investment because these investments are typically made on a no-fee or lower fee basis and “juice the performance from private equity.”

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