Notes from the frontline – Andrew Lebus, Pantheon Ventures

While private equity has been more insulated from the financial crisis than some other sectors of the financial markets, it is inevitable that the asset class will be affected. Public market valuations have suffered and private equity valuations are also, therefore, falling and we will probably see significant valuation decline and even some company failures next year. Fundraising is taking longer and debt is hard to secure.

However, I don’t think these factors alone will force fundamental change. Private equity is endlessly creative and will adapt to a new cycle, returning to its core business model – growth. Good practices, which might have been overshadowed by the effects on returns of leverage, are now resurfacing. The end of cheap credit means that operational improvement will be the only driver of returns. What may occasion real change are significant increases in regulation on both sides of the Atlantic.

Andrew Lebus

The current state of the market hasn’t led us to make any significant change to our investment strategy, or drastically to revise our way of operating. We see turbulent market conditions as a chance for private equity to return to an emphasis on the trading outlooks of underlying companies and on liquidity. Our experience since 1982 has taught us that the best vintages have often stemmed from market dislocation. We have a disciplined and diversified investment process, across geographies, stages of investment and both primary funds and secondary assets. This process has proved itself through previous market cycles and puts us in a strong position to deal with this downturn.

What do we see as trends?  It’s probably too early to say with any certainty, but in terms of our regional perspectives, we believe the emerging markets should continue to produce interesting investment opportunities. We invest selectively in Russia, Latin America, Africa and Central and Eastern Europe, and have been present in Asia since 1992. Asia has now come to form a core part of many investors’ strategies, though the theory of Asian decoupling is not one to which we have subscribed. Asia has indeed been touched by the credit crisis, but we believe that the region is less likely to suffer from a protracted downturn than the West. Strong economic fundamentals and good growth prospects underpin our belief that we will see a flow of investment opportunities there in the next couple of years.

The next 12 months will be very challenging for the private equity industry, in terms of returns and on the regulatory front. We expect there to be clearer delineation between the strongest teams and the rest, which means LP access to top private equity fund managers will be even more important.

2008 has seen increasing dealflow in secondary assets, as institutions seek to achieve liquidity or restructure their portfolios in deteriorating economic conditions. But a pricing gap between buyers and sellers remains and significant trading will not really take off until next year. We expect this market to generate transactions involving more complex asset mixes and anticipate seeing increasingly creative solutions emerging to resolve liquidity and portfolio management needs.

Andrew Lebus is a managing partner at fund of funds Pantheon Ventures, as well as manager of the London-listed Pantheon International Participations fund of funds investment trust.