Quest for Alpha drives Limited Partners to focus on more concentrated Private Equity portfolios to counteract compression of returns, says bfinance   Global private equity survey of General Partners and Limited Partners shows a widespread agreement that average returns will compress by as much as 1000 basis points   In a major global private equity survey of General Partners and Limited Partners undertaken by bfinance, an independent specialist financial services consulting firm, findings released today show a fall in expected internal rate of returns (IIR) of 5-10% over the coming years.  Combined with expectations by over 81% of Limited Partners* of higher dispersion and significant increased volatility of private equity returns, 71% of institutions surveyed plan to narrow existing General Partner relationships and narrow the number of funds in their portfolios to avoid the expected compression of returns. The survey shows that over 74% of Limited Partners target net returns in IRR terms above 15% from private equity investments, continuing to make private equity play a key role in institutional portfolios as a source of return enhancement and risk diversification. Allocations to private equity are mostly stable, despite the vast majority expecting to see average returns in the industry fall.   Responses from Limited Partners and General Partners indicate the reasons for expected compression of industry returns are three fold; significant capital over-hang (un-invested capital) pushing mangers to aggressively try to find opportunities at often higher prices, reduced and more selective access to leverage and a more challenging economic environment affecting companies’ growth. It is this backdrop which is also driving expectations of a wider dispersion of returns.   The survey questioned 49 Limited Partners of whom 53% had between US$2 billion and US$10 billion in assets under management (AUM) and 22% had over US$10 billion in AUM.  A further 31 General Partners globally were also polled, of which 43% had between US$500 million and US$2 billion and 22% had above US$10 billion AUM.  Key facts include:   ·         71% of Limited Partners continue to allocate to private equity as a way to obtain return enhancement in their portfolio. 70% expect private equity strategies (buyout, venture and special situations) to return in IRR terms above 15% and 31% of Limited Partners expect returns above 20%.   ·         66% of Limited Partners expect general industry returns in IRR terms to compress by 5-10% with General Partners even more pessimistic; 73% expect internal rate of return compression of 5-10% and 12% expect a decline of over 10%.   ·         54% of Limited Partners indicate that they do not expect to accept any return compression in their own portfolios and 46% expect to accept 5-10% in IRR terms.   ·         71% of Limited Partners expect to narrow the number of General Partner relationships to reduce the dispersion and enhance private equity returns compared to the expected compressed average returns.   ·         97% of General Partners expect to maintain or increase assets under management between now and 2015. Despite 85% of them forecasting general compression of returns above 5%, 69% expect not to be affected at all directly by the expected industry wide compression.   ·         Private equity return expectations diverge between Limited Partners and General Partners. 31% of institutional investors expect private equity returns in IRR terms above 20% over the life a typical buyout fund compared to 53%% of General Partners.   Olivier Cassin, Managing Director, Head of Research and Development, at bfinance commented: “Private equity will remain a key source of diversification for institutional investors but in an environment of falling expected average returns combined with a greater dispersion, careful General Partner selection will become even more important. Our survey highlights a trend which we see amongst our clients: Limited Partners are moving away from passive allocaton to private equity and increasingly are seeking help to identify managers that will generate consistent returns in the future based on sustainable competitive edges. Consequently, we are experiencing a stronger demand for specialist investment advice in this area as investors seek to maintain the quality of their exposure.”   Lorenzo Rossi, Managing Director of Private Equity at bfinance, added: “We see attractive returns being generated at asset/company level despite the weak economic cycle.  In order to achieve attractive net return targets, investors need to ensure they fully understand where value is created and when/why value often leaks before it accrues to them.  We remain very positive about private equity as an asset class, if investors approach it as active investors seeking transparency and influencing managers.”