Private Equity Pending - December 2016 - Oil and Gas Investor
Unlike publicly traded securities, private equity investments march to a different tune, both in terms of upfront commitments and later moves to liquidate assets. Private equity commitments are often spaced out over several years, and the results tend to come in over a similar timeframe. According to Bill Weidner, president of Weidner Advisors LLC, based in Simsbury, Connecticut, private equity is still dealing with a variety of legacy issues in energy—some helpful, some less so.
"The low interest rate environment still exists," he noted, "and that has been a tailwind behind a lot of money coming into energy. Bond yields are low, leaving large pension funds and retirement funds desperate for returns to fund their obligations. To the extent we’re facing the start of a secular rise in rates, the demand for alternatives is probably as great as ever to make up for the resulting decline in value of longer-term bonds."
Historical outperformance by energy—once also a tailwind—has of course crumbled with the fall in commodity prices, first with the collapse in natural gas prices in 2009 and more recently with crude.
Lately, a number of funds have been "putting up some pretty decent returns" that are buoyed by rising valuations in the Permian Basin, said Weidner. But there was "so much money looking for energy earlier that a lot of committed capital has yet to be funded, regardless of what happened over the last two years. It was already allocated, already committed, and it’s probably going out."
In addition, recent investor conversations have included cautionary remarks, such as "I don’t want to invest more until we get our capital back," according to Weidner. "That sentiment probably throttles back some money coming into the space on a temporary basis." One recent issue has been a pushback by investors with regard to fees to private equity sponsors. "There’s been a lot of pressure from limited partner investors to keep a lid on management fees, in particular fees paid during an investment period when there’s capital committed but not yet invested," said Weidner. Also, some investors have opted to take smaller fund positions with a sponsor, leaving the door open to "co-invest" alongside the sponsor on a more efficient basis, he said. "We’ve seen an increase in that in the last few years."
Jeff Eaton is a partner with Eaton Partners, an international fund advisory and placement agent that works with a network of institutional investors in managing fund raises across a variety of alternative asset classes.
Eaton Partners, located in Rowayton, Connecticut, is active in energy and other real asset sectors. In 2015, it raised $1.9 billion for New Jersey-based Ridgewood Energy Corp.
"This year feels like it might be slightly better than last year, but I don’t think it’s going to be a banner year, by any means," he said. "The current fund-raising picture isn’t a particularly encouraging one for many of the traditional energy funds."
While institutions are being encouraged to step in and "buy at the bottom" of the cycle, "most of the funds are structured so that you have four to five years to invest the money," he noted. "Managers are not supposed to put all that money to work in one year. After heavy investment inflows in 2013-2014, there should be a significant amount left to give investors exposure in 2016-2017. So investors are not necessarily thinking they have to put more money to work now to catch the bottom."
However, Eaton Partners is seeing increased interest in managers who differentiate themselves by specializing in more specific strategies.
"For instance, we are seeing increased interest in mineral royalty strategies, production-focused strategies, or distress for control or buyout strategies," said Eaton. "The more ‘typical’ energy private equity model of backing management teams with an equity line of credit, whether or not the team actually has an asset lined up, is a more difficult strategy to raise money for today."
As some investors have become more sophisticated in energy, they are also increasingly "going direct" as opposed to investing through a fund manager, according to Eaton. With investors in some cases now having their own geological and technical staffs, they can choose to invest directly in private E&Ps or opt to co-invest alongside a fund manager. This has been happening in the Delaware Basin, he said.
While these investments may result in lower "blended" management fees, the ability to concentrate investments can cut both ways, offering a higher return potential, but also less diversification, greater risk and the possibility of adverse selection. "If you overweight one or two deals, and those deals end up being the lesser performing deals in the portfolio, you’re going to have a worse return than on the fund’s portfolio, even if your fees are blended down," commented Eaton. "Also, the deals that are offered up for co-investment are often larger deals, and some people would argue that sometimes the larger deals are the less attractive deals."
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