A year into the pandemic - where are we now?
Last year will certainly be one to remember as unprecedented restrictions on movement and government interventions led to a very different way of life and working for many of Europe’s citizens. And while the uncertainty prevalent in the early phases of the pandemic were evident in European private equity activity for the first half of 2020, over 4,179 deals closed in the full year, valued at €449.1bn, according to PitchBook figures, down less than 3% on figures for 2019 for both value and volume.
It has clearly been a busy time for European private equity, but what are some of the longer term impacts of the pandemic? And where can Europe really shine in an LP portfolio?
In terms of performance, Europe’s private equity managers have upped their game recently, according to Richard Hope, Head of EMEA at Hamilton Lane. “We’ve just conducted a market overview of US versus European private equity performance,” he explains. “It is clear that, for the first time, we are now seeing Europe outperform the US. It’s very positive to see such strong returns coming from Europe.”
He points to historic issues such as a difficulty for LPs accessing some opportunities because of Europe’s fragmented markets – “there is quite a dichotomy between the pan-regional platforms and the more complex situations with country funds,” he says.
“There is also a consideration around the percentage of companies with private equity funding,” adds Hope. “In some markets, such as Germany, private equity penetration is low; in other markets, such as the Nordic countries, it’s higher, but there is some way to go to see high levels of private equity exposure across the European market.”
He is positive about Europe’s prospects as more European funds develop and grow, in particular now that Brexit uncertainty has largely settled. “We see a greater appetite for private equity because companies are clearly opting to stay private for longer,” he says. “That offers good opportunities across the private equity, growth and venture capital spectrum.”
Europe’s funds continued to gain LPs’ attention through 2020, with the year’s fundraising totals finishing at a strong €92bn, down on 2019 (€102bn) but up on 2018 (€71bn), PitchBook numbers show. Yet the number of funds raised was down substantially, from 154 in 2019 to just 90 in 2020, suggesting a continuation of the trend towards concentration of capital among fewer, larger funds.
Getting traction with LPs takes skill and determination, but the events of last year necessitated new approaches, some of which may endure long past the pandemic. For Katja Salovaara, Senior Investment Officer, Private Equity, at Office of New York City Comptroller, there has been no question of pausing new commitments. “We’re open for business and we were throughout 2020,” she says. “We made the technology work for us. We managed to execute on all our 2020 priorities and work through our fund pipeline, all virtually. If we’d taken a pause, we’d have missed out on some great GPs and vintages.”
And while a poll at SuperReturn Europe 2021 found that a third of participants felt GP-LP relationships had become weaker as a result of switching to virtual fundraising and investor relations, Salovaara points to some benefits of the new ways of working. “The future is likely to be a hybrid of face-to-face and virtual fundraising,” she says. "Using technology, you can engage more people if needed and you can break up due diligence processes over several days rather than feeling you have to get them done during visits. That can help you tailor your work to the situation and get in front of the right people. We have also found that you can have high quality meetings via virtual technologies.”
For individual European firms, differentiation has always been an area of focus – to attract both capital and high quality portfolio companies. And here, we are seeing continued evolution, says Rainer Ender, Head of Private Equity at Schroder Adveq. “Europe has been on a 20-year journey towards specialisation and that is still happening,” he notes. “This is giving teams the ability to generate repeatable successes and it gives them a USP. Some firms have grown bigger, even though they have specialisms, and you are seeing some now raise smaller funds once again for particular strategies and leveraging their experience base.”
Yet while specialisation can act as a strong differentiator, LPs are also now looking more closely at how firms operate and treat their people – particularly given that the pandemic may have exposed some fault lines.
“LPs increasingly want to hear not just about the hard skills of deal sourcing and operational skills, but also the softer side of managing a private equity firm – the culture and how values are woven through the organisation,” says Christopher Bär, Managing Director at MPEP Luxembourg Investments. “That’s really important to understanding a firm’s approach and can provide competitive advantage in a crowded market.”
And there is one area in particular where European private equity can really turn heads, particularly post-pandemic: ESG. While the move towards incorporating ESG considerations into investment processes has been happening for a few years now, an increased recognition that we live on a highly interconnected planet in which actions taken in one part of the world can affect people thousands of miles away has made sustainability a bigger priority for LPs than ever before.
“We are seeing an enormous increase in the number of sustainable funds – that’s being driven by investors that really want to back these trends,” says Miriam Schmitter, Managing Director, Commonfund Capital. “There’s a much better recognition now that you can achieve good returns from sustainable investments if you back the right GPs. That’s helped by the fact that the opportunity set has increased enormously over the past five years.”
Europe has a definite advantage in this regard. Many European funds had already embarked on integrating ESG into their investment processes, but the EU’s new Sustainable Finance Disclosure Regulation will bring benefits to LPs as fund managers marketing to EU investors are required to produce ESG reporting. Its Taxonomy Regulation will also establish criteria on whether an economic activity is environmentally sustainable.
As Dana Haimoff, Managing Director at JP Morgan points out: “Europe is clearly yards and yards ahead of the US on ESG, particularly from a regulatory standpoint, where, as it should be, it is front and centre. ESG considerations will become even more embedded in how we invest and monitor as more LPs drive this focus forward.”
Simon Marc, Senior Managing Director and Global Head of Private Equity at PSP Investments illustrates this perfectly. “The responsible lens is a driver of who we partner with,” he explains. “We are an investor over the long term, not just four to five years. We look decades ahead. ESG is a driver of value and we want to be an investor in companies that will be here a great many years from now. If you’re on the wrong side of sustainability – in terms of customers, suppliers, employees – capital will flow away from you. It’s at the heart of value creation.”
And while moves to create a more standardised approach to ESG measurement and reporting are global, regulations such as the EU taxonomy will assist LPs at least in the interim.
“It’s still early days in terms of ESG measuring and metrics,” says Marc. “We are seeing a move away from an investor relations approach of storytelling and towards a more consistent data-driven approach. There needs to be a measurement system, but it has to be broader than that. We need to be able to look across the portfolio and across managers to assess performance on material ESG factors. When this is achieved, it will be an important milestone not only for LPs, but also for our contributors and beneficiaries.”
