probitas private equity survey trends 2014
DESCRIPTION
Survey of limited partners in October 2014TRANSCRIPT
Private Equity Institutional Investor Trends for 2014 Survey
Probitas Partners is a leading independent knowledge, innovation, and solutions provider to private markets clients. We serve both institutional investors who seek to place capital and select leading fund sponsors who seek to raise capital for private equity, real estate, infrastructure, credit, special situations, and hedge funds. These services are offered by a team of employee owners dedicated to leveraging the firm’s vast knowledge and technical resources to provide the best results for all its clients.
On an ongoing basis, Probitas Partners offers research and investment tools for the alternative investment market as aids to its institutional investor and general partner clients. Probitas Partners compiles data from various trade and other sources and then vets and enhances that data via its team’s broad knowledge of the market.
n. [from Latin probitas: good, proper, honest.] adherence to the highest principles, ideals and character.
probity ¯ ¯˘
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© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
C o n t e n t s
The Private Equity Fundraising Environment ...................................2
Private Equity Institutional Investor Survey ......................................3
Overview of Survey Findings ..............................................................3
Profile of Respondents .......................................................................4
Sectors and Geographies of Interest ................................................8
U.S. Middle-Market Funds ................................................................20
Venture Capital .................................................................................21
Niche Private Equity Sectors ............................................................22
Fund Structures and Key Terms .......................................................27
Investor Fears and Concerns ...........................................................30
Our View of the Future .....................................................................33
Chart I Global Commitments Private Equity Partnerships
USD
in b
illio
ns
600
500
400
300
200
100
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 3Q YTD
2013
Source: Thomson Reuter
20 27 40 4964
97
148175
301
175
94 99
138
306
392
490 477
170
262
168
276
205
2
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
The Private Equity Fundraising Environment
• Fundraising in2013 isonpace toexceed2012’s totalas theprivateequitymarketsreturntonormalcyinthewakeoftheFinancialCrisis.
• Differenttrendsfrom2012underliethetoplinenumbersinChartI.
• Megabuyout funds in theUnitedStatesandEuropeare raising large fundsthatareboostingoverallcommitments—butmostofthesefundsaretargetingsmallerfundsthantheydidatthemarketpeak.
• In Asia, a relative strong point during the Financial Crisis, fundraising hasfallen significantly in 2012 and 2013 — especially for RMB-denominated,China-focusedfundsthathadbeengrowingsteadilysince2006.
• The overhang of undrawn commitments that built up from vintage year2006 through 2008 funds is now finally burning off, releasing pressure onlimitedpartners’allocations.
• Interest in secondary funds and distressed debt funds is moderating fromlastyear.
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© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Private Equity Institutional Investor Survey
Probitas Partners conducted its online survey to measure investor interest,opinions, and perspectives on investing in private equity in October 2013. Thissurvey is administered annually to gauge emerging trends and to compareinvestors’changingviewsovera longerperiodoftime.Onehundredandthirty-seven responses were received from senior investment executives globally,representing such institutions as public and corporate pension plans, fund-of-funds,familyoffices,endowmentsandfoundations,andconsultantsandadvisors.
Overview of Survey Findings
Thefollowingsummarizesthetop-linefindingsfromthesurvey:
• Steady interest in private equity. The rebound from the Financial Crisiscontinues,andinvestorsarelikelytocommitslightlymoretoprivateequityin2014than2013.Thoughtheappetitefornewmanagersisincreasing,anumberofinvestorsremainfocusedontriagingcurrentfundmanagerrelationshipsasthe lastgroupofmanagers yet to raise since thebeginningof the FinancialCrisiscomesbacktomarket.
• Continued focus on smaller buyout and growth capital funds. Investorsremainfocusedonsmaller-andmiddle-marketbuyoutandgrowthcapitalfundsintheUnitedStatesandEuropetodiversifyportfoliosandcommitcapitaltostrategieswheremanagerscanproverecurringaddedvalue.
• Many investors have already established core relationshipsinthesesectors,soarenotlookingtoaddmanynewones.
• Interest in emerging markets is declining. Investors are increasinglyconcernedwithpoliticalrisk intheemergingmarketsandare lessconvincedthat the inherent high growth story necessarily leads to strong privateequitygains.
• Credit Vehicles (distinct from mezzanine funds) are rising in interest.Credit-oriented strategies and vehicles have come into fashion, especiallyseniordebtandopportunisticcreditstrategiesinEuropeandNorthAmerica,asdifficultiesinthedebtmarketshavecontinuedtocreateopportunities.
• Energy focused funds remain a significant focus for investors, especially in North America.Thisistrueinnosmallpartduetooutperformancethesectorhasdeliveredoverthepastcoupleofyearscomparedwiththebroaderprivateequitymarkets.
• Large investors increasingly focused on co-investments.Largeinvestorswiththeteamandcapitalresourcesnecessarytodevelopco-investmentprogramsare increasinglytargetingco-investments inanefforttoenhanceoverallandnetreturns;thelargestinvestorsarepursuingdirectinvestmentsaswell.
Chart II Respondents by Institution TypeI represent a:
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
Public Pension
Corporate Pension/ Private Pension Plan
Endowment/Foundation
Fund-of-Funds Manager
Family Office
Sovereign Wealth Fund/Government Entity
Insurance Company
Bank
Consultant/Advisor
Other
3%13%
4%
14%
11%5%
9%
31%
6%4%
4
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
Profile of Respondents
• Therewere137respondentstothesurvey;mostrespondentswerefrompensionplans,funds-of-funds,insurancecompanies,andfamilyoffices(ChartII).
• Respondents were geographically diverse, with strong participation fromNorthAmerica,Europe,andAsia;withinAsiatherewasaparticularlystrongresponsefromJapan(ChartIII).
• AsChartIVdetails,manyinvestorsarenearthetopoftheirallocations,thoughinvestorsexpressedmoreallocationflexibilitythisyearthantheyhadlastyear.
• Funds-of-fundsaredifferent—allocationsarenotreallyrelevantastheirabilitytoinvestisdrivenbytheirabilitytoraisefundvehiclesorseparateaccounts.
Chart III Respondents by Firm HeadquartersMy firm is headquartered in:
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
Western Europe
North America
Asia/Middle East
Australia21%
4%
33%42%
Chart IV Current and Target Private Equity AllocationsAs far as our current private equity allocation, we are:
Roughly at our target and are looking to maintain that level of exposure
Under our target allocation and actively committing to private equity to achieve that target
Over our target and are looking to reduce exposure to meet that target
Roughly at our target but considering increasing the target
Over our target but seeking to increase the target
Looking to reduce our target and exit the asset class
A fund-of-funds or consultant to which the question does not apply
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 5 10 15 20 25 30 35 40 45
20132014
31
1617
26
76
1
20
4
3739
12
29
5
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Chart V Drivers of Sector InvestmentOur sector investment focus in 2014 is being driven by:
My institution simply pursues the best funds and managers available in the market
A focus on those private equity sectors I believe will outperform others in this vintage year
Maintaining established relationships with fund managers returning to market this year
Targeting funds that will provide access to co-investments
My institution’s need to diversify its private equity portfolio
My need to decrease exposure to private equity
My need to deploy significant amounts of capital allocated to private equity
The strategies that my clients have directed us to pursue
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50
47
12
9
7
3
2
14
5
1
6
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• Whatdrivesinvestorstoinvest?ConsistentwithProbitasPartners’pastsurveys,allotherreasonsaresecondaryto“pursuingthebestavailablemanagersandfunds,”thoughthefocusonbestmanagershasbecomeincreasinglyimportanttoinvestorssincetheFinancialCrisis(ChartV).
• Proven,topquartilemanagerscanbedifficulttoaccess,andsincefundsonlycome to market every three to five years, many investors feel compelled tocommittothesemanagerswhentheyareavailableandopen.
• Family offices are much more likely to focus on private equity sectors theybelievewilloutperform,with33%ofthoserespondentsfollowingthatstrategy.
• Morerespondentsarelookingtoincreasecommitmentsas2014approaches,continuingtheallocationreboundafterthebottomofthefundraisingmarketin2009(ChartVI).
• ChartVII shows that two-thirdsof respondentsare focusedon their currentgeneralpartnerrelationships,withonly28%strongly focusedondevelopingnewgeneralpartnerrelationships.
• Basedonourdiscussionswithinvestors,manycontinuetheprocessoftriaginggeneralpartnerrelationshipsthattheybeganfollowingtheFinancialCrisis.
• Only3%ofrespondentstargetedseparateaccountsastheirprimarymeansofinvestinginprivateequity,thesamenumberaslastyear.
Chart VI Private Equity AllocationsFor 2014, we or the clients we advise are looking to commit across all areas of private equity (in USD):
Perc
enta
ge o
f Res
pond
ents
(%)
30
25
20
15
10
5
0
<$50 MM $50 MM– $150 MM
$150 MM– $250 MM
$250 MM– $500 MM
$500 MM– $1 B
>$1 B
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
20132014
19
15
26
22
16
21
1718
13
10 9
14
Chart VII Manager RelationshipsDuring 2014, we would expect our primary focus to be:
Evaluating re-ups with current general partner relationships with a limited look at new relationships
Evaluating re-ups with current general partner relationships, looking to decrease the number of relationships significantly
Evaluating re-ups with current general partner relationships
Actively pursuing relationships with new managers
Pursuing separate accounts with a smaller number of managers
Our 2014 commitments have already been completely allocated
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60
85
55
2828
33
22
20132014
03
5454
7
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Chart VIII Private Equity Sectors of InterestDuring 2014, my firm or my clients plan to focus most of our attention on investing in the following sectors (choose no more than five):
U.S. Middle-Market Buyouts ($500 million to $2.5 billion)
European Middle-Market Buyouts — Country-Focused
U.S. Small-Market Buyouts (>$500 million)
Growth Capital Funds
Energy Funds
European Middle-Market Buyouts — Pan-European
U.S. Large Buyouts ($2.5 billion to $5 billion)
Credit Strategies
Secondary Funds
Distressed Debt Funds
Asian Country-Focused Funds
Infrastructure Funds
Mezzanine Funds
Pan-Asian Funds
U.S. Venture Capital
Restructuring Funds
Fund-of-Funds
Emerging Markets (ex-Asia)
Mega Buyout Funds (>$5 billion or equivalent)
Cleantech/Green-Focused Funds
Mining Funds
European/Israeli Venture Capital
Agriculture Funds
Timber Funds
Other Niche Sectors
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70
62
43
41
25
18
15
12
9
9
16
16
19
20
22
23
25
26
30
8
3
3
2
2
2
5
8
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
Sectors and Geographies of Interest
ChartVIIIdetailsthesectorsofinteresttoinvestorsfor2014:
• Ashasbeenthecaseinmostofourprevioussurveys,middle-marketbuyoutsandgrowthcapitalintheUnitedStatesandEuropedominateinterest.
• Interest inAsiancountry-focused fundsdeclined from24% last year to19%thisyearbecauseofcontinuingconcernsaboutChina.
Table I Investors Focus of Attention Among Private Equity Sectors Top Five Responses:
2007 2014
Sector % Targeting Sector % Targeting
U.S. Middle-Market Buyouts 49% U.S. Middle-Market Buyouts 62%
European Middle-Market Buyouts 42% European Middle-Market Buyouts 43%
U.S. Venture Capital 34% U.S. Small-Market Buyouts 41%
Distressed Debt 30% Growth Capital 30%
Asian Funds 25% Energy Funds 25%
Source: Probitas Partners’ Survey of Institutional Limited Partners, 2007 & 2014
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© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
• Atthemargin,thereisslightlyincreasedinterestinhardassetstrategies,butthe interest isscatteredamongst infrastructure,agriculture,miningandtimberfunds—strategies thatmayormaynotbepartofprivateequityallocationsforrespondents.
• Megabuyoutfundscontinuedtorankverylowininterest,continuingtheresultsofourpriorsurveys,evenatthepeakofthemarket.Whileinvestorscontinuetoexpressalackofinterest,thesefundscontinuetoattractsubstantialcapitalinthemarket.
TableIcomparesthetop-rankedareasofinterestfromour2007survey(thesurveybeforetheFinancialCrisis)andthecurrentsurvey.Thefindingsarenotsurprising:
• U.S.andEuropeanmiddle-marketbuyout fundsscoredextremelywellbeforeandaftertheFinancialCrisis.
• InterestinU.S.VentureCapitalhasfallensignificantlyfrom2007,withonly15%ofrespondentstargetingitin2014,rankingonly15thamongallstrategies.
• EvenattheearlystagesoftheFinancialCrisis,interestindistresseddebtwashighasinvestorslookedtohedgetheirbetsinafrothyenvironment.Interestindistresseddebthasmoderatedsincethenastheexpected“100-yearflood”ofdistressedopportunitiesincorporatedebtfailedtomaterialize.
• Energy-focused fundssoared into the top five in2014on thebackof stronginterest from North American respondents, with 40% of them targetingthesector.
Chart IX Private Equity Sectors of Interest; European Respondents
European Middle-Market Buyouts — Country-Focused
U.S. Middle-Market Buyouts ($500 million to $2.5 billion)
U.S. Small-Market Buyouts (<$500 million)
Growth Capital Funds
European Middle-Market Buyouts — Pan-European
Infrastructure Funds
Credit Strategies
U.S. Large Buyouts ($2.5 billion to $5 billion)
Asian Country-Focused Funds
Restructuring Funds
Distressed Debt Funds
Energy Funds
Mezzanine Funds
Pan-Asian Funds
Emerging Markets (ex-Asia)
Secondary Funds
Fund-of-Funds
U.S. Venture Capital
Mega Buyout Funds (>$5 billion or equivalent)
Cleantech/Green-Focused Funds
European/Israeli Venture Capital
Mining Funds
Agriculture Funds
Timber Funds
Other Niche Sectors
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70 80
78
40
33
22
11
11
7
4
7
11
11
13
16
18
18
24
24
31
60
4
0
2
2
2
2
10
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
U.S.middle-marketbuyouts’toprankinginthesurveyreflectsthefactthat42%oftherespondentsarefromNorthAmerica.Thistrendisdrivenbythefactthatmostinvestorspreferlocalfundsandstrategieswhenbuildingcoreportfolios,andthenextend their portfolios geographically as they gain knowledge and experience,and seek greater diversification. Charts IX and X, respectively, provide a lookat theprivateequityworld through theeyesofEuropeanandAsian/Australianrespondents.
• Not surprisingly, Chart IX shows European country-focused middle-marketbuyoutsasthetoprankedinterestforEuropeaninvestorswhilemiddle-marketPan-Europeanfundsalsoscoredwell.
• U.S. middle-market buyouts were also of interest to Europeans, whileinfrastructureandcreditstrategiesalsoscoredwell.
Chart X Private Equity Sectors of Interest; Asian Respondents
U.S. Middle-Market Buyouts ($500 million to $2.5 billion)
Asian Country-Focused Funds
Pan-Asian Funds
European Middle-Market Buyouts — Pan-European
Infrastructure Funds
Secondary Funds
U.S. Large-Buyouts ($2.5 billion to $5 billion)
Mezzanine Funds
Energy Funds
Growth Capital Funds
U.S. Small-Market Buyouts (<$500 million)
European Middle-Market Buyouts -— Country-Focused
Credit Strategies
Mega Buyout Funds (>$5 billion or equivalent)
Restructuring Funds
Fund-of-Funds
Distressed Debt Funds
Cleantech/Green-Focused Funds
U.S. Venture Capital
Mining Funds
Timber Funds
Emerging Markets (ex-Asia)
European/Israeli Venture Capital
Agriculture Funds
Other Niche Sectors
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60
52
35
35
28
21
14
14
7
10
14
14
21
21
24
24
28
28
31
3
3
0
0
0
0
7
11
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
• U.S. venture capital was of little interest — though it did outscore Europeanventurecapital.
• AsshowninChartX,Asianinvestorslookattheirhomemarketsmorefavorably,thoughU.S.middle-marketbuyoutsarestillthemajorsectorofchoice.
• European country-focused fundsandU.S. venture capital areof significantlylessinteresttoAsianinvestors;theyaremuchmoreinterestedininfrastructureandsecondaryfunds.
• Asianrespondentswerealsomuchmorefocusedontraditionalprivateequitystrategies with little interest in alternative sectors like emerging marketsoutsideofAsia,timber,andagriculture.
Chart XI Private Equity Geographical FocusDuring 2014, I anticipate that the three major geographical focuses for our program will be:
Perc
enta
ge o
f Res
pond
ents
(%)
100
90
80
70
60
50
40
30
20
10
0
North America
Western Europe
Asia Emerging Markets Globally
Latin America
Central and Eastern Europe
Africa MENA Other
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
2 2
92
49
139
85
51
12
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• Asfarasgeneralgeographic interest,thethreemajorgeographiesofNorthAmerica, Western Europe, and Asia continue to dominate investor interest(ChartXI).
• Notably, there was less interest in Asia reflected in this year’s survey, withrespondents targeting Asia falling from 65% from two years ago to 49%thisyear.
• Interestinemergingmarketsglobally,aswellastheindividualregionsoutsideofAsia,hasalsodeclinedoverthepastyear.
20132014
Chart XII Most Attractive European MarketsFor European country/regionally-focused funds, I find the most attractive markets to be (choose no more than three):
Nordic Region
Germany
United Kingdom
Benelux
Europe via Pan-European funds
I do not invest in Europe
France
Central Europe (Poland, Czech Republic, Hungary, etc.)
Eastern Europe (Russia, Ukraine, Georgia, etc.)
Europe via fund-of-funds
Spain
Italy
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70
4848
2120
1217
79
1010
37
26
42
73
24
4940
6062
24
13
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
• As far as European markets, for the seventh consecutive year, institutionalinvestors preferred to invest in the Nordic Region by a significant margin(ChartXII).
• Germany and the United Kingdom, once again rounded out the top threegeographiesofinterest,thoughinterestintheU.K.surgedthisyear.
• Italy and Spain have rebounded slightly from last year, as both countriescontinuedtodealwiththeirmacroeconomicissues.
• Interest inCentralandEasternEuropedeclinednoticeably fromalready lowlevelstotrailallotherEuropeangeographies.
Chart XIII Most Attractive European Markets; European RespondentsFor European country/regionally-focused funds, I find the most attractive markets to be (choose no more than three):
Nordic Region
United Kingdom
Germany
Benelux
France
Spain
Italy
Central Europe (Poland, Czech Republic, Hungary, etc.)
Eastern Europe (Russia, Ukraine, Georgia, etc.)
Europe via fund-of-funds
Europe via Pan-European funds
I do not invest in Europe
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70 80 90
Overall RespondentsEuropean Respondents
8260
02
22
73
04
3321
6749
6748
07
1117
1110
77
42
14
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• AsChartXIIIhighlights,Europeaninvestorsviewtheirhomemarketsimilarlytoglobalinvestorsintermsofgreatestareasofinterest,butwithevenmorefocusontheNordicRegion,theUnitedKingdom,andGermany.
• Europeans,aswithglobal investors, remain leeryofEasternEurope,CentralEurope,andSouthernEuropegiventhecurrenteconomicenvironment.
ChartXIVhighlightsrespondents’interestinAsiangeographiesgoinginto2014.
• ChinaremainsthetopAsiangeographyofinterestamongallparties,thoughinterestcontinuedtodeclinefromitshighof55%threeyearsagoto38%now.
Chart XIV Most Attractive Asian Markets; Asian RespondentsWhich Asian markets do you find most attractive at the moment (choose no more than three):
China
Australia
Japan
Southeast Asia
Pan-Asian funds
South Korea
India
Vietnam
Indonesia
Taiwan
Asia via global funds
Asia via fund-of-funds
I do not invest in Asia
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60
3621
1422
1420
07
1114
42
02
44
6
5421
4338
7
0
01
4
22
2
Overall RespondentsAsian Respondents
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© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
• InterestinJapansurgedfrom9%lastyearto22%thisyearonthebackoftheintroductionofAbenomicsinstitutedbythenewgovernment.
• ThebiggestdifferencebetweenAsianrespondentsandoverallrespondentsthisyearisamuchgreaterinterestinJapan;however,therewereadisproportionatenumberofJapaneserespondentsinthesurveythisyearfocusedontheirhomemarket,skewingtheAsianresults.
• In last year’s survey, 30% of overall respondents targeted India, while thisyearonly7%ofoverallrespondentsandnoneoftheAsianrespondentswerefocusedonit.
• Indonesianinterestfellto2%thisyearfrom14%lastyearasmanyinvestorshavemadebetsonIndonesiaoverthelasttwoyearsandnowhavebaselineexposures and are increasingly concerned about liquidity and politicalstabilitythere.
Table II Which Geographies in Asia Are of the Most Interest in Private Equity? Top four responses:
2007 2014
Country/Region % Targeting Country/Region % Targeting
China 28% China 38%
India 28% Southeast Asia 22%
Japan 25% Australia 22%
I do not invest in Asia 25% Japan 22%
Source: Probitas Partners’ Survey of Institutional Limited Partners, 2007 & 2014
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Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
TableIIhighlightshowinvestorinterestswithintheAsianmarkethavechangedsincetheFinancialCrisisstarted.
• In2007,China,India,andJapanenjoyednearlyequalinvestorinterest.Sincethen, interest in Indiahas fallenprecipitouslyas investorsgrew increasinglyconcernedoveralackofexits.
• AppetiteforJapanhasgonethroughacycleofsteadydeclinethrough2013,thenreboundingstronglythisyearonthebackoftheeconomicpoliciesofthenewJapanesegovernment.
• InterestinSoutheastAsianfundshasincreasedonlyoverthelastthreeyears,driveninpartbyinvestor’sdesiretodiversifyawayfromChinaexposure,whileAustralia benefits in this year’s survey from a large number of Australianrespondentstargetingtheirhomemarket.
• Thebiggestchangeinemergingmarketinterestoverthelastyear,detailedinChartXV,istheincreasednumbernotinvestinginemergingmarkets—nearlydoublelastyear,risingfrom18%to32%.
• China and Brazil continue to lead investors’ interest in emerging markets,thoughinterestinbothhasdeclinednoticeablyoverthelastyear.
• Interest in India continued its decline the last few years as investorscomplain about the lack of exits from previous Indian funds they backed,while interest in Turkey plummeted as political turmoil negatively affectedinvestor’sperceptions.
• TheotherBRICcountry—Russia—continuedtotrailsignificantlyinthesurvey,asithasforanumberofyears.Limitedpartnerstellusthattheyareconcernedaboutinvestors’rightsunderRussianlaw.
Chart XV Most Attractive Emerging MarketsWhich emerging markets do you find most attractive (choose no more than four):
China
Brazil
Turkey
Southeast Asia
Indonesia
I do not invest in emerging markets
Pan-Latin America
India
South Korea
Central Europe (Poland, Czech Republic, Hungary, etc.)
Colombia
Mexico
Pan-Asia
Russia
Peru
Eastern Europe (Russia, Ukraine, Georgia, etc.)
Chile
MENA
I only invest in global emerging market funds
Vietnam
Sub-Saharan Africa
Other
Emerging market via funds-of-funds
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 5 10 15 20 25 30 35 40
20132014
33
18
20
18
23
9
10
10
6
54
8
6
2
3
2
13
33
5
20
11
32
1817
12
610
7
98
118
24
4
0
2
3
6
3
3
3
5
38
20
7
17
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Chart XVI Interest in Emerging Market Private EquityMy interest in emerging market private equity is driven by (check all that apply):
Strong long-term economic growth in a number of these countries
Desire to diversify my private equity portfolio by geography to achieve benefits of lack of correlation
I am less interested in emerging markets in general than in exposure to a few specific countries with large opportunities
Lower forecast returns in the established markets of private equity make this sector relatively more attractive
As an institutional investor from an emerging market, I am looking to support my home markets
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60
55
36
20
18
3
10
18
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• Thedrivingfactorthatattractedinvestor’sinterestinemergingmarketswastheprospectofstronglong-termeconomicgrowththatwaslikelytopositivelyimpact returns. However, the number of respondents who felt compelled toinvest inemergingmarketsonthattheorydroppedfrom77%twoyearsagoto55%(ChartXVI).
• For investors who are not interested in emerging markets (Chart XVII), thereasonsaremuchmorediverseandnotdominatedbyasinglereason.
Chart XVII Disinterest in Emerging Market Private EquityFor those not interested in emerging markets, I am not interested because (check all that apply):
I find the risk/return profile in developed markets more attractive
I am not staffed properly to perform due diligence on these markets that basically offer emerging manager risk as well as emerging markets risks
These markets are not developed enough and it is difficult to find experienced managers with strong track records
I am uncomfortable with the degree of political, currency, or economic risk in emerging markets
As an organization, we are satisfied to get emerging markets exposure through
publicly-traded securities
My private equity program is relatively new, and we are focused on building exposure in our core, home markets before diversifying
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 5 10 15 20 25 30 35 40 45
40
38
32
28
17
13
13
19
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Chart XVIII Most Attractive U.S. Middle-Market SectorsWhich of these sectors/strategies in the U.S. middle market do you find most appealing (check all that apply):
Funds focused on operational improvements heavily staffed with professionals with operating backgrounds
Funds focused on buy-and-build strategies
Restructuring/turnaround funds
Funds focused on single industries (i.e., retail, healthcare, media)
Strategy is irrelevant, a demonstrable superior track record is my only concern
Funds focused on growth companies, often investing without majority control
Regionally-focused funds
U.S. middle market via fund-of-funds
I do not invest in the U.S. middle market
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70
62
40
19
2
29
27
22
13
3
15
20
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
U.S. Middle-Market Funds
• Fund managers in the large, homogeneous market in the United Statesare predominantly differentiated by investment strategies rather thangeographicdifferences.
• The majority of respondents indicated a strong preference for funds thatgenerated returns viaoperational improvementsand thatwere staffedwithoperatingprofessionals.Thisisconsistentnotonlywithpastsurveyresultsbutalsoacrossallinvestortypes(ChartXVIII).
• Asian investors are more focused on buy-and-build strategies, with 47% ofrespondentstargetingthatapproach.
• The least favored strategy across all investor types are regionally-focusedfunds.
Chart XIX Most Attractive Venture Capital SectorsIn venture capital I focus on funds active in the following sectors or stages (choose all that apply):
Funds investing in multiple sectors
Technology only funds
Life science only funds
Cleantech only funds
Multi-stage
Late stage
Mid-stage
Early stage
Seed stage
Only historic returns no matter the sector
Venture capital via fund-of-funds
I do not invest in venture capital
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50
24
27
2
3
7
26
4
14
44
17
19
8
19
21
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Venture Capital
• Venture investor interest in stage and sector remains static over our lastseveralsurveys, though interest incleantech-focused fundshascontinuedtodwindletoaverylowlevel(ChartXIX).
• Endowments and foundations remain much more active in venture capitalthan other investors and focused on early stage investments, with 63% ofrespondentstargetingthatstage.
• Since2007,thenumberofrespondentswhodonotinvestinventurecapitalhasmorethandoubled,from17%to44%.Asianinvestorsarethemostnegativeonthesector,with54%ofrespondentssayingtheydonotinvestinitatall,whileendowments are the most positive, with all of those respondents targetingthesector.
Chart XX Distressed InvestmentsWithin the distressed debt/restructuring sector, I am most interested in (choose no more than two):
Restructuring/turnaround funds (focused on equity, not debt)
Distressed debt for control funds (loan-to-own)
Opportunistic credit (mispriced debt, small loan portfolios, etc.)
Distressed debt: active/non-control funds
Distressed debt trading funds
Distressed debt hedge funds
I do not invest in this sector
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60
26
21
18
3
50
55
3
1
22
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
Niche Private Equity Sectors
• There are several distinct distressed strategies, but many fund managerspursueacombinationoftheseapproacheswithinthesamefund.
• Most respondentspreferstrategieswithavalue-added focus thatgenerateshighermultiplesofreturn.Inallourprevioussurveys,restructuring/turnaroundfundsanddistresseddebtforcontrolfundshaveswitchedbackandforthfortheleadinthesector(ChartXX).
• Opportunisticcredit funds (thatusuallyhaveastrong focusonassetsotherthan corporate debt) are another area of focus for investors. While someinvestorshaveexpandedtheirdistresseddebtcategorytoincludemorecreditstrategies,othersstillconsideritastraightcreditorfixedincomeproduct,andthereforenotintheiralternativesallocation.
Chart XXI CreditIn the credit sector, my firm:
Perc
enta
ge o
f Res
pond
ents
(%)
100
80
60
40
20
0
Mezzanine Senior Debt BDCs/Publicly Listed Opportunistic Credit
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
Considers credit sector investmentsDoes not invest in this sector Invests but not as part of a private equity allocation
Invests as part of private equity allocation
35
12
14
39
48
13
21
18
90
26
21
11
42
334
23
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
• Over the past three years investors have been increasingly focused on theprivateequitycreditsectorastheylookatopportunitiescreatedbythestrainedbankandCLOmarkets.
• Respondentstothesurveyaremorefocusedonthemezzanine,opportunisticcredit, and senior credit sectors, although a number of investors make theircommitments to these strategies outside their private equity allocations(ChartXXI).
• Few respondents to the survey were interested in business developmentcompaniesorotherpubliclylistedvehicles.
Chart XXII Secondary Market InvestmentsIn the secondary market, my firm (choose all that apply):
Actively purchases direct positions in funds in the secondary market
Actively invests in secondary funds
Has sold or is considering selling funds in our portfolio for portfolio management purposes
Provides advice to clients on secondaries
Is not active in secondaries in any manner
Actively purchases direct positions in companies in the secondary market
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50
45
38
31
19
18
13
4
24
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• Chart XXII reflects very few changes in investor preferences since last year,witha largenumberofrespondentsactivelypurchasingsecondarypositionsdirectlyorinvestingthroughsecondaryfunds.
• The secondary market is clearly maturing. The percentage of investors whohavesoldorareconsideringsellingfundsfromtheirportfolioreachedanall-timehighthisyearwhilethepercentageofrespondentswhoarenotactiveinsecondariesinanymannerisatanall-timelow.
Chart XXIII Directs and Co-InvestmentsRegarding directs and co-investments, my firm (choose all that apply):
Has an active internal co-investment program
Only opportunistically pursues co-investments
Does not invest in co-investments nor directly invests in companies
Provides advice to clients on co-investment or direct investments
Invests directly in companies
Requires or prefers a co-investment as a means of diligencing a new fund manager
Has an outsourced co-investment program
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 SurveyNote: “Large Investors” denotes those survey respondents who plan to commit $500 million or more to private equity in 2014
0 10 20 30 40 50 60
Large InvestorsAll Respondents
30
3019
3426
3559
1211
1226
47
20
14
25
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
• AsChartXXIIIdetails,themajorityofinstitutionalinvestorsdonotpursueco-investmentsordirect investments,oronlydosoopportunisticallybecauseofstafforcapitallimitations.
• However, the largest investors are much more likely to have an active co-investmentprogram;59%oftheselargerespondentshaveanactiveinternalco-investmentprogram,whileanother7%haveoutsourcedprogramsand11%investdirectlyincompanies.
Chart XXIV Publicly Traded Private Equity VehiclesAs far as publicly traded private equity vehicles, my firm (choose all that apply):
Has not made an investment in the sector in the past and has no plans to do so
Previously invested in the sector but is decreasing or eliminating our exposure
Has invested in publicly traded private equity fund-of-funds and plans to maintain or build
this exposure in the future
Has not made an investment in the sector in the past but is considering doing so
Has invested in publicly traded private equity vehicles that invest directly in companies and plans to
maintain or build this exposure in the future
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70 80 90
2013 2014
43
25
79
29
22
2
86
4
26
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• ComingoutoftheFinancialCrisis,therehasbeenrenewedinterestinpublicly-tradedvehicles, eitherat themanagementcompany levelor the investmentvehiclelevel.
• However, there remains little interest in investing in this sector amonginstitutional private equity investors, across all types or geographies ofinvestors,atrendthatwasmorepronouncedthisyear(ChartXXIV).
Chart XXV Issues Regarding Fund StructureThe issues I focus on most when investing or advising a client as far as terms or structure of a fund are (choose no more than three):
Level of general partner financial commitment to the fund
Distribution of carried interest between the senior investment professionals
Overall level of management fees
Structure or inclusion of a key man provision
Carry distribution waterfalls
Cap on fund size
Transaction fee splits
Ownership of the management company
Level of carried interest
Structure or inclusion of a no-fault divorce clause
Sharing of carry and/or investment decision making with a third-party sponsor
Strict adherence to the ILPA Private Equity Principles
Inclusion of a strong environmental, social, and governance “ESG” policy
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
0 10 20 30 40 50 60 70
17
19
29
30
36
36
46
48
48
12
10
60
3
10
27
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Fund Structures and Key Terms
• As with most of our past surveys, the level of general partner financialcommitment to a fund remains the most important term for investors as itis one of the key factors in assuring alignment of interest between limitedpartnersandgeneralpartners(ChartXXV).
• Europeaninvestorsweremorefocusedonthelevelofmanagementfees,with64% of respondents focused on that attribute, while Asian investors ranked“KeyMan”provisionsassecondontheirlistofmostimportantterms.
• Forthefirsttimethisyearweaskedinvestorshowimportantstrictadherencetothe ILPAPrivateEquityPrinciplesor the inclusionofastrongESGpolicywas inreviewingfundstructuresandterms.Overallneitheroftheseissuesrankedhighly,though 24% of pension plan respondents targeted strict ILPA compliance and20%ofEuropeanrespondentsfeltthatstrongESGpolicieswereimportant.AsianandAustralianinvestorswereleastconcernedwiththeseissues,andnoneofthefamilyofficeorinsurancecompanyresponseswereconcernedwithESGpolicies.
28
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• InpastsurveysweaskedinvestorsinmoredetailabouttheILPAPrivateEquityPrinciplesandfoundthatthoughfewinvestorsinsistedonstrictcompliancetothePrinciples,amajorityofinvestorsofalltypesusedthemasastartingpointfortermsnegotiations.
• AfterapauseduringtheFinancialCrisis,therehasbeenaresurgenceinthird-partyinvestmentinprivateequitymanagementcompanies.
• Similar to our previous surveys, limited partners’ strongest reaction is thattheseinvestmentscreatepossibleconflictsofinterestbetweeninvestorswhoacquire positions in general partner management companies and limitedpartnersinthefunds(ChartXXVI).
• Though many investors feel these structures create potential conflicts ofinterest, only 22% stated that this would lead them to reject investing inthe underlying funds, down from 41% last year. Geographically, there is adistinctdifference,withonly5%ofAsianinvestorssayingtheywouldrejectafundbecauseof third-party investment in thegeneralpartner,while31%ofEuropeanrespondentssaidthattheywouldrejectsuchafund.
• Only 6% of respondents felt that investing in a private equity managementcompanyrepresentedanattractiveopportunity.
Chart XXVI Third-Party Investments in Private Equity Management CompaniesI believe third-party ownership of private equity management companies (choose all that apply):
Raises the possibility of conflicts of interest between limited partners and investors
Leads me to reject investing in the underlying private equity funds
Is better handled through private as opposed to public structures
Is a natural response to succession issues in private equity funds
Is likely to expand significantly beyond the large funds that have such relationships
Is irrelevant to the fund investment process
Presents an interesting investment opportunity
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
6
7
17
20
22
80
3
0 10 20 30 40 50 60 70 80
18
29
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
30
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
Investor Fears and Concerns
• The greatest fear of most private equity investors was that large funds arebecoming generalized asset managers and are moving away from their keyinvestmentstrengths.Lastyear,thiswasonlythethirdmostnotedissuewith33%ofrespondentsmentioningit(ChartXXVII).Europeaninvestorsfeltevenmorestronglyaboutthisissue,with64%mentioningit.
• ThebiggestdifferencegeographicallywasinAsia,wherethegreatestconcern(mentioned by 40% of respondents) was that too much money was chasingtoofewexperiencedprivateequityprofessionals inwhatarebecomingover-heatedemergingmarkets.
• Fears thateconomicdifficultieswould impactalternative investment returnsfell significantly from the first-ranked issue last year (mentioned by 48% ofrespondents)toonlyfifthplacethisyear.
• Wealsoencouragedrespondentstostatetheirowngreatestfearsorconcernsnotincludedinourpre-setlist.Answersincludedthefollowing:
• Fund managers do not have enough “skin in the game” and as a consequence we are starting to see again practices seen prior to the Financial Crisis in terms of leverage level, especially in the United States.
• The opportunity is good, but the investment structures are poor.
• Lack of adequate exit opportunities (IPOs, strategic buyers) to absorb the number of companies that will need to be exited over the next two to four years.
• Credit bubble fed by aggressive searches of yield will cause another private equity crisis in a few years’ time.
• Poor liquidity and distributions.
• Generational transition at firms when heir apparents likely have modest attributable track records largely from the last ten years.
• Too much secondary capital to be invested and the rapid increase in co-investment activity.
• Large limited partners are not being active enough with their general partners.
• Are the right funds getting funded, are the right limited partners getting access, are the right entrepreneurs getting funded?
Chart XXVII Greatest Fears Regarding the Private Equity MarketMy three greatest fears regarding the private equity market at the moment are:
Large firms in the market are becoming generalized asset managers and moving away from key investment strengths
Management fee levels and transaction fees on large funds are destroying alignment of interest between fund managers and investors
Private equity is most effective as a niche market — too much money is being raised in all private equity sectors
Too much money pursuing too few experienced private equity professionals in the hot emerging markets
Economic difficulties will have widespread impact on all alternative investment returns
Commitment overhang and allocation pressure will continue to impact my ability to invest in attractive opportunities in 2014
Investment by third parties into fund management companies is decreasing alignment of interest between limited partners and general partners
Access to top quartile venture capital managers is impossible without previous relationship, and new managers are unattractive
We do not have adequate staff in place to deal with issues in my current portfolio
The private equity market is increasingly illiquid, hampering returns and limiting my ability to reinvest
The venture capital investing model is broken and future strong performance is unlikely to return
Continued volatile IPO markets will negatively impact venture capital returns
The number of funds in my portfolio is too large for my firm to effectively monitor
Decreasing opportunities are limiting my access to co-investments
I find myself increasingly at odds with other limited partners due to preferential treatment
Decreased leverage availability will hurt companies needing working capital or re-financing
Another technology bubble is in the process of forming
Other
Percentage of Respondents (%)
Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2014 Survey
46
38
36
20
7
6
7
8
8
15
28
30
6
6
3
5
5
9
0 10 20 30 40 50
31
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Table III What keeps you up at night? Top three responses:
2007 2014
Issue % Targeting Issue % Targeting
Management fee levels and transaction fees on large funds are destroying alignment of interest between fund managers and investors.
51%Large firms in the market are becoming generalized asset managers and are moving away from their key investment strengths.
46%
The amount of leverage in the buyout market is unsustainable, and over the next two years credit problems will hurt performance of recent vintage funds.
48%Management fee levels and transaction fees on large funds are destroying alignment of interest between fund managers and investors.
38%
There is too much money available in the large buyout market and this will dramatically impact future returns.
44% Private equity is most effective as a niche market — too much money is being raised in all sectors.
36%
Source: Probitas Partners’ Survey of Institutional Limited Partners, 2007 & 2014
32
Private Equity Institutional Investor Trends for 2014 Survey © 2013 Probitas Partners
• Table III takes us back to the beginning of 2007 and highlights investors’concernspre-FinancialCrisisandcomparesthemtofearsgoinginto2014.
• Concerns about management fees and transaction fees destroyingalignment of interest were among the top three concerns pre- and post-FinancialCrisis.In2007investorswereveryawarethattherewastoomuchdebtandequityavailableinthebuyoutmarketandthatthestrongreturnsleadingupto2007andbeyondwereunlikelytocontinue.
• In this year’s survey,nearlyhalfof the respondentswereconcerned thatlargefirmsinthemarketwerebecomingassetmanagersfocusedonAUMgrowthandweremovingaway from their key investment strengths—anissuethatwasnottopicalin2007.
• In2007,amajorconcernofinvestorswasthattoomuchmoneywasgoingintothelargemarket;by2014theconcernwasthattoomuchmoneywasgoingintoprivateequityoverall.
33
© 2013 Probitas Partners Private Equity Institutional Investor Trends for 2014 Survey
Our View of the Future
Severalkeytrendsfor2014emergefromthesurveyandourongoingconversationswithinvestors:
• Fundraising globally will hit a new post-Financial Crisis high this year with continuing strength in 2014.WeaknessinAsiaandemergingmarketfundraising are being made up by strong interest in North America andEurope,whilesignificantrealizationsandcontinuedstrongpublicmarketsvaluationsaregivinglimitedpartnersmoreroomtodeploycapital.However,thestaffofmanylimitedpartnersisbeingstressedbyawaveofre-upsthatisaffectingtheirbandwidthtoreviewnewrelationships.
• The new performance metric — cash — driving increased exits. Manyinvestorshaveaddedakeymetricofperformance to IRRandmultipleofcapital: distributions on paid in capital (“DPI”), or actual cash returned.Thisnewmetricisforcinggreaterrealizationsbeforemanyfundmanagersareabletosecurenewfundcommitments. InNorthAmericaandEurope,increaseddistributionsareleadingmanyinvestorstorecyclecashreceivedintonewcommitmentstofundswithsolidDPIperformance.
• Investors are becoming more cautious regarding emerging markets.Anumberofkeyemergingmarketshavebeenplaguedbylimitedliquiditywhileothershavesufferedfrompoliticalturmoil.Thoughinvestorsbelievethatthelong-termeconomicgrowthpotentialofemergingmarketsishigh,theyarelesscertainoftheshorter-termprospectsforprivateequityreturnsinspecificmarkets,especiallycomparedwithwhatappeartobecompetitivereturnsindevelopedmarketswithlessrisk.
• Interest in venture capital will remain weak — but that is not necessarily bad.Alargenumberofinvestorshavegivenuponventurecapitalentirely,with 43% of respondents to this year’s survey saying they do not investin venture capital, the highest mark ever. However, a number of limitedpartners still targeting the sector believe that the lack of price inflationforventurecompanyinvestmentsthatshouldresultfromlesscompetitionshouldincreasefutureventurecapitalreturns.
• Increased interest in hard asset plays.Anumberofsophisticatedinvestorsworried about economic uncertainty and future asset shortages, as wellasthoseseekingtomatchlong-termliabilities,areincreasinglyturningtohardassetsectorssuchasenergy,agriculture,mining,andtimber.Severalpensionfundshavecreatedseparateinflation-linkedallocationsoutsideoftheirprivateequity,realestateanddebtallocations,thoughmanyinvestorswith theseallocationsexpress frustrationbecause thereare fewproductsavailablewithexperiencedmanagementteamsanddeeptrackrecords.
• The past as future — “middle-market, operationally-focused funds.”Inallofourpastsurveysandconversationswithinvestors,therehasalwaysbeenapronouncedpreferenceformiddle-marketbuyoutfundswithoperationalfocus.Wedonotexpectthattochangeprospectively.Whatdoescontinuetovaryonthetopic,however,isthedefinitionofwhat“middlemarket”is,orwhatdefinesan “operational focus.”Given increased interested in thespace,weexpecttoseebroaderdefinitionsemerge.
Probitas Funds Group, LLC Probitas Funds Group, LLC PFG-UK Ltd. Probitas Hong Kong Limited
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Private Equity Institutional Investor Trends for 2014 Survey