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How Do Investors Perceive New Regulation in the Private Equity Asset Class? – November 2014

by Scott Gibbs

  • 07 Nov 2014
  • PE

Performance has always been seen as the main factor affecting investor appetite for private equity; however, is it always the biggest challenge investors face? There are many other important factors that affect investor demand, including regulations, fees, transparency and the current economic climate, to name a few. Regulations have been receiving a lot of media coverage recently, with the introduction of AIFMD in July this year and the upcoming Solvency II the focus of this attention. While regulations are designed to benefit the private equity industry as a whole, they could actually result in less investment in the asset class, as LPs remain uncertain over their possible effects. 

The Preqin Investor Outlook: Alternative Assets H2 2014 surveyed 100 investors in private equity to gather their views about the industry. It revealed that the largest proportion (30%) of investors thought that regulation was the biggest issue they faced when operating a private equity portfolio. This is a substantial increase on June 2012 and December 2012, where 5% and 15% of investors respectively stated regulations as their biggest concern. By June 2013, 11% of LPs surveyed had already reduced their allocation to private equity in response to regulations. 

In H2 2014, fees were the next biggest issue facing investors, with 26% of investors expressing concern; this could be due to the higher operating costs that fund managers will face as a result of the new reporting requirements of AIFMD. Consequently, many investors remain sceptical as to how these costs will be spread, whether or not they will be incorporated into management fees, or if fund managers will bear the burden themselves, again reiterating the uncertainty investors face when investing in the asset class. 

Solvency II will not come into effect until 2016, however due to the long-term nature of alternative assets, insurance companies will certainly be taking the effects of this regulation into account when planning their next investments. Solvency II will require insurance companies to provide more information about their investments and to make improvements to their risk management. Like AIFMD, this will make investments in the alternative asset classes more costly, and as a result, many insurers have already expressed doubt over their future involvement in private equity. 

Data from the Preqin Investor Outlook: Alternative Assets H2 2014 survey clearly shows that even though the full effects of these regulations are yet to be felt, there remains a sense of uncertainty surrounding them, with investors voicing a genuine concern. The regulations are certainly a step in the right direction for the asset class, increasing transparency, reducing risk for investors and bringing European companies together under the same regulation. However, they may actually hamper the profitability of the asset class in the short term, due to the increase in administration and compliance costs that will result from adhering to these regulations. Preqin is currently conducting similar research into investors’ attitudes, the results of which will be published in early 2015; it will be interesting to see whether investors have changed their outlook on the regulations’ impact, or whether their concerns will have grown deeper.

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