Private Equity Institutional Investor Trends for 2016 Survey Probity ¯¯˘ N

Private Equity Institutional Investor Trends for 2016 Survey probity ¯¯˘ n. [from Latin probitas: good, proper, honest.] adherence to the highest principles, ideals and character.

On an ongoing basis, Probitas Partners offers research and investment tools for the alternative investment market to aid 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. Contents

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...... 10

Emerging Markets...... 22

U.S. Middle-Market Funds...... 26

Venture Capital...... 28

Distressed Private Equity...... 29

Credit-Focused Funds...... 30

Real Asset Funds...... 31

Secondary Market...... 32

Co-Investments and Direct Investments...... 33

Fund Structures and Key Terms...... 34

Investor Fears and Concerns...... 37

Our View of the Future...... 40

Fundraising in 2015 slowed significantly in the third quarter, though a boom in fourth quarter fundraising, as has happened in the last two years, could bring the “A boom in full-year total up to 2014’s level. fourth quarter The trends that underlie the top line numbers in Chart I: fundraising, as Funds targeting North America make up more than 50% of all fundraising. has happened in Mega buyout funds in the United States and Europe are raising large funds the last two years, that are boosting overall commitments — but most of these funds are targeting smaller funds than they raised at the last market peak. could bring the After rebounding significantly in 2014, interest in Asia has slowed so far in full-year total up 2015 due to increased concerns about China. to 2014’s level.” The overhang of undrawn commitments has also increased over the last two years, reaching an all-time high of $1.3 trillion.

Chart I Commitments to Global Private Equity Partnerships

500 452 450 420 400 367 371 372 350 300 267 241 250 250 226 229 199 193 200 USD in billions 148 150 136 106 80 100 50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 3Q YTD 2015

Source: PREQIN, does not include funds-of-funds

Probitas Partners conducted its annual online survey in late September/early October 2015 to gauge investor interest, opinions, and perspectives on investing in private equity. This survey is designed to track emerging trends and to compare investors’ changing views over a longer period of time. One hundred and four responses were received from senior investment executives globally, representing such institutions as public and corporate pension plans, funds-of-funds, insurance companies, family offices, endowments and foundations, and consultants and advisors.

Overview of Survey Findings

The following summarizes the top-line findings from the survey:

Steady interest in private equity. Investors are focused on redeploying the large amounts of capital that have been returned to them over the last three years, though the strong pace of new commitments over this period means a number of investors are nearing the top of their allocations.

. . . though one of investors’ strongest fears is that the market is nearing the top of the cycle. This fear runs across geographies and across different types of investors.

Continued focus on smaller buyout and growth capital funds. Investors remain focused on smaller and middle-market buyout and growth capital funds in the United States and Europe that pursue strategies where they believe managers can deliver recurring added value.

. . . but many investors fear that purchase price multiples in these sectors are too high. Even as investors express interest in the sector, they are concerned that the high prices now being paid will drive down future returns.

Buyout and growth capital sector-focused funds are of interest to investors. Though interest in the energy sector has fallen with turmoil in the oil and gas markets, there is strong interest in healthcare and technology- focused funds.

Interest in emerging markets has remained fairly steady overall. However, certain countries, like Russia, attract little interest due to political issues and falling oil prices, while interest in Brazil has also fallen significantly with economic problems and political turmoil.

Despite the advent of Unicorns, interest in venture capital remains muted. Interest in the sector mainly comes from North American investors focused on U.S. venture capital; European and Asian investors remain unimpressed.

There were 104 respondents to the survey; most respondents were from pension plans, funds-of-funds, insurance companies, and family offices (Chart II).

Respondents were geographically diverse, with strong participation from the United States, Europe, and Asia (Chart III).

As Chart IV details, more investors are near their target allocations, with less room to back new relationships.

Funds-of-funds are different — allocations are not really relevant as their ability to invest is driven by their ability to raise fund vehicles or separate accounts.

Chart II Respondents by Institution Type I represent a:

Funds-of-Funds Manager 29% 1% 1% 3% Consultant/Advisor

3% 17% Insurance Company 5%

8% Family Office

13% 10% Public Pension 10% Endowment/Foundation

Corporate Pension/ Private Pension Plan

Sovereign Wealth Fund/ Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey Government Entity

Taft-Hartley or Industry Pension Plan

Bank

Other

47% United States

Canada 5%

Western Europe 3%

5% Japan 22% 8% Asia ex-Japan 10%

Australia

Middle East

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Roughly at our target and are looking to 27 maintain that level of exposure 23

Under our target allocation and actively committing 17 to private equity to achieve that target 29 Roughly at our target but considering 16 increasing the target 6 Over our target and are looking to reduce 2 exposure to meet that target 2 1 Over our target but seeking to increase the target 2

0 Looking to reduce our target and exit the asset class 0

A fund-of-funds or consultant to which 33 the question does not apply 38 4 Other 0

0 5 10 15 20 25 30 35 40

Percentage of Respondents (%)

2016 2015

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 6 What drives investors to invest? Consistent with Probitas Partners’ past surveys, all other reasons are secondary to “pursuing the best available managers and funds,” though the focus on best managers has become increasingly important to investors since the Global Financial Crisis (Chart V).

Proven, top quartile managers can be difficult to access, and since funds typically come to market every three to five years, many investors feel compelled to commit to these managers when they are available and open.

Pension plans are more likely to target funds that will provide them access to co- investments, with 25% of them focused on this strategy.

Chart V Drivers of Sector Investment Our sector investment focus in 2016 will be driven by (choose no more than two):

My institution simply pursues the best funds 40 and managers available in the market A focus on those private equity sectors I believe 16 will outperform others in this vintage year Maintaining established relationships with fund 14 managers returning to market this year Targeting funds that will provide 11 access to co-investments The strategies that my clients 10 have directed us to pursue My need to deploy significant amounts 5 of capital allocated to private equity My institution’s need to diversify 4 its private equity portfolio My need to decrease exposure 0 to private equity

Other 2

0 10 20 30 40 50

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 7 More respondents are looking to increase commitments as 2016 approaches, continuing the allocation rebound after the bottom of the fundraising market in 2009 (Chart VI). “There is a strong There is a strong focus this year (as there has been in the past) on re-ups with a limited look at developing new general partner relationships (Chart VII). focus...on re-ups

Based on our discussions with investors, many are continuing to triage their with a limited look relationships, looking to upgrade their portfolio quality by not re-upping with fund managers that had weak returns over the last cycle and putting more money to at developing new work with fewer selected managers. general partner Only 3% of respondents targeted separate accounts as their primary means of relationships.” investing in private equity.

Chart VI Private Equity Allocations For 2016, we or the clients we advise are looking to commit across all areas of private equity (in USD):

25 23 22 20 20 21 20 19

15 15 14 14

10 11 10 9

Percentage of Respondents (%) of Respondents Percentage 2 0 0 Other <$50 MM $50 MM– $150 MM– $250 MM– $500 MM– >$1 B $150 MM $250 MM $500 MM $1 B

2016 2015

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Evaluating re-ups with current general partner relationships 54 with a limited look at new relationships 63

27 Actively pursuing relationships with new managers 26

Evaluating re-ups with current 7 general partner relationships 4

Evaluating re-ups with current general partner 6 relationships, looking to decrease the 2 number of relationships significantly

Pursuing separate accounts with 3 a smaller number of managers 2

Our 2016 commitments have already 0 been completely allocated 0

3 Other 3

0 10 20 30 40 50 60 70

Percentage of Respondents (%)

2016 2015

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Chart VIII details the sectors of interest to investors for 2016:

Middle-market buyouts and growth capital in the United States and Europe dominate interest, as has been the case in most of our previous surveys.

Interest in distressed debt increased from 20% in 2014 to 31% this year.

Interest in energy-focused funds declined from 31% last year to 20% this year in the midst of market turbulence in the sector.

Table I compares the top-ranked areas of interest from our 2007 survey (the one immediately before the Global Financial Crisis) and the current survey.

The latest survey contained more options than 2007 but U.S. middle-buyout funds still lead.

U.S. venture capital ranked third in 2007 and only eighth in 2016, though that ranking is actually a significant rebound from fifteenth place in 2014. Among North American investors, venture capital in 2016 ranked fourth, with 47% targeting it.

Distressed debt was just off the 2016 table in the seventh position with 31% targeting it.

Table I Institutional Investors Focus of Attention Among Private Equity Sectors Top Five Responses:

2007 2016

Sector % Targeting Sector % Targeting

U.S. Middle-Market Buyouts 49% U.S. Middle-Market Buyouts 76%

European Middle-Market Buyouts 42% U.S. Small-Market Buyouts 46%

U.S. Venture Capital 34% European Buyouts — Pan-European 43%

Growth Capital Funds — Developed Distressed Debt 30% 42% Markets European Middle-Market Buyouts — Asian Funds 25% 41% Country or Region-Focused

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2007 Survey and 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 10 Chart VIII Private Equity Sectors of Interest During 2016, my firm or my clients plan to focus most of our attention on investing in the following sectors (choose no more than seven):

U.S. Middle-Market Buyouts ($500 million to $2.5 billion) 76

U.S. Small-Market Buyouts (<$500 million) 46

European Buyouts — Pan-European 43

Growth Capital Funds — Developed Markets 42

European Middle-Market Buyouts — Country or Region-Focused 41

U.S. Large Buyouts ($2.5 billion to $5 billion) 34 Distressed Debt Funds 31

U.S. Venture Capital 30

Pan-Asian Funds 29

Asian Country-Focused Funds 27

Direct Lending/Credit Strategies 26

Infrastructure Funds 24

Energy Funds 20

Restructuring Funds 19

Secondary Funds 19

Mega Buyout Funds (>$5 billion or equivalent) 19

Mezzanine Funds 16

Emerging Markets (ex-Asia) 13

Fund-of-Funds 7

Mining Funds 6

European/Israeli Venture Capital 5

Agriculture Funds 4

Timber Funds 4

Cleantech/Green-Focused Funds 4

Shariah-Compliant Funds 0

Other Niche Sectors 8

0 10 20 30 40 50 60 70 80

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 11 U.S. middle-market buyouts’ top ranking in the survey reflects, in part, the fact that 52% of the respondents were from the United States or Canada. Most investors prefer local funds and strategies when building out their core portfolio, and then extend their portfolios geographically as they gain knowledge and experience, and seek greater diversification. Charts IX and X, respectively, provide a look at the private equity world through the eyes of European and Asian/Australian/Middle Eastern respondents, while Chart XI focuses on North American respondents.

Interestingly, Chart IX shows U.S. middle-market buyouts as the top ranked interest for European investors, while European county-focused and Pan-European funds ranked second and third, respectively.

Pan-Asian and Asian country-focused funds also charted well among European investors, as did direct lending funds.

U.S. venture capital was of less interest than it was to overall respondents — though it outscored European venture capital by a significant margin.

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 12 Chart IX Private Equity Sectors of Interest; European Respondents During 2016, I plan to focus most of my attention on investing in the following sectors (choose no more than seven):

U.S. Middle-Market Buyouts ($500 million to $2.5 billion) 78

European Middle-Market Buyouts — Country or Region-Focused 70

European Buyouts — Pan-European 52

Growth Capital Funds — Developed Markets 48

Pan-Asian Funds 48

Asian Country-Focused Funds 43

U.S. Small-Market Buyouts (<$500 million) 39

Direct Lending/Credit Strategies 30

Infrastructure Funds 30

U.S. Large-Buyouts ($2.5 billion to $5 billion) 26

Distressed Debt Funds 26

Mezzanine Funds 26

U.S. Venture Capital 22

Mega Buyout Funds (>$5 billion or equivalent) 22

Restructuring Funds 17

Emerging Markets (ex-Asia) 17 Energy Funds 13

Secondary Funds 13

European/Israeli Venture Capital 9 Cleantech/Green-Focused Funds 9

Mining Funds 9

Fund-of-Funds 4

Agriculture Funds 4

Timber Funds 4

Shariah-Compliant Funds 0

Other Niche Sectors 13

0 10 20 30 40 50 60 70 80 90

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 13 As shown in Chart X, Asian/Australian/Middle Eastern investors look on Asian markets more favorably, though both U.S. middle-market buyouts and Pan- European buyouts are major sectors of choice. “Asian A number of investors make infrastructure investments out of their private equity allocations rather than separate infrastructure allocations. Asian respondents respondents were much more interested in infrastructure than other respondents, driven by very strong support from Japan. were much more

These investors had little interest in energy or U.S. venture capital funds, while interested in two respondents to the “Other Niche Sectors” option said that they were targeting Asia/China venture capital. infrastructure than other respondents.”

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 14 Chart X Private Equity Sectors of Interest; Asian/Australian/Middle Eastern Respondents During 2016, I plan to focus most of my attention on investing in the following sectors (choose no more than seven):

U.S. Middle-Market Buyouts ($500 million to $2.5 billion) 58

Infrastructure Funds 50

European Buyouts — Pan-European 38

U.S. Large-Buyouts ($2.5 billion to $5 billion) 35

Asian Country-Focused Funds 31

Direct Lending/Credit Strategies 31

Pan-Asian Funds 27

European Middle-Market Buyouts — Country or Region-Focused 23

Secondary Funds 23

Growth Capital Funds — Developed Markets 19

Mezzanine Funds 19

Distressed Debt Funds 15

U.S. Small-Market Buyouts (<$500 million) 12 Energy Funds 12

Fund-of-Funds 12

Emerging Markets (ex-Asia) 8

Mega Buyout Funds (>$5 billion or equivalent) 8

Agriculture Funds 8

Cleantech/Green-Focused Funds 8

Timber Funds 8

Restructuring Funds 4

U.S. Venture Capital 4

Mining Funds 4

Shariah-Compliant Funds 0

European/Israeli Venture Capital 0

Other Niche Sectors 8

0 10 20 30 40 50 60

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 15 North American respondents were much more interested in U.S. venture capital, distressed debt, and energy than respondents from other geographies.

There was much less interest in infrastructure funds, though that may reflect that in North America infrastructure investments were much more likely to be made through separate infrastructure allocations.

Asian-focused funds also generated less interest from North American respondents.

Chart XI Private Equity Sectors of Interest; North American Respondents During 2016, I plan to focus most of my attention on investing in the following sectors (choose no more than five):

U.S. Middle-Market Buyouts ($500 million to $2.5 billion) 85

U.S. Small-Market Buyouts (<$500 million) 66

Growth Capital Funds — Developed Markets 51

U.S. Venture Capital 47

Distressed Debt Funds 42

European Buyouts — Pan-European 42

European Middle-Market Buyouts — Country or Region-Focused 38

U.S. Large Buyouts ($2.5 billion to $5 billion) 38

Energy Funds 26

Restructuring Funds 26

Direct Lending/Credit Strategies 23

Pan-Asian Funds 23

Mega Buyout Funds (>$5 billion or equivalent) 23

Secondary Funds 19

Asian Country-Focused Funds 19

Emerging Markets (ex-Asia) 13

Mezzanine Funds 9

Infrastructure Funds 8

Mining Funds 6

Fund-of-Funds 6

European/Israeli Venture Capital 6

Agriculture Funds 2

Timber Funds 2

Shariah-Compliant Funds 0

Cleantech/Green-Focused Funds 0

Other Niche Sectors 6

0 20 40 60 80 100

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 16 As far as general geographic interest, the three major geographies — North America, Western Europe, and Asia continue to dominate investor interest (Chart XII).

Notably, interest in Asia rebounded somewhat from 49% last year to 56% this year.

Interest in emerging markets outside of Asia remained scattered with no geography dominant.

Chart XII Private Equity Geographical Focus During 2016, I anticipate that the three primary areas of geographical focus for our programs will be:

100 94 90 81 80

60 56

30 Percentage of Respondents (%) of Respondents Percentage 20 14

10 4 2 2 1 1 0 North Western Asia Emerging Latin Central and Sub-Saharan MENA Other America Europe Markets America Eastern Africa Globally Europe

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 17 As far as European markets, interest in the United Kingdom and the Nordic Region tied this year, a slight shift from last year’s results which had the United Kingdom somewhat ahead (Chart XIII).

Germany ranked third, and the top three markets strongly outpaced the rest of Europe.

Italy rebounded slightly from last year’s very low level, while interest in Spain and France continue to be relatively low.

There was no interest in Eastern Europe as the ongoing Ukrainian crisis and continued political issues between Russia and the West dimmed investor enthusiasm.

Chart XIII Most Attractive European Markets For European country/regionally-focused funds, I find the most attractive markets to be (choose no more than three):

58 Nordic Region 59 58 United Kingdom 66 39 Germany 37 16 Benelux 22 14 Spain 12

10 France 10 8 Italy 4

Central Europe (Poland, Czech 5 Republic, Hungary, etc.) 5 Eastern Europe (Russia, 1 Ukraine, Georgia, etc.) 2 18 I only invest via Pan-European funds 15 3 I only invest via fund-of-funds 1 13 I do not invest in Europe 11 0 Other 4

0 10 20 30 40 50 60 70

Percentage of Respondents (%)

2016 2015

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 18 As Chart XIV highlights, European investors view their home market similarly to global investors in terms of greatest areas of interest, but with even more focus on the United Kingdom and the Nordic Region.

The biggest difference between European and other investors is a much stronger interest in Spain and Central Europe, as well as the fact that fewer Europeans invest in Europe solely through funds-of-funds.

Chart XIV Most Attractive European Markets; European Respondents For European country/regionally-focused funds, I find the most attractive markets to be (choose no more than three):

58 Nordic Region 71

58 United Kingdom 76

39 Germany 33

18 France 14

16 Benelux 19

10 Spain 29

8 Italy 5

Central Europe (Poland, Czech 3 Republic, Hungary, etc.) 10

Eastern Europe (Russia, 1 Ukraine, Georgia, etc.) 0

14 I only invest via Pan-European funds 10

13 I only invest via fund-of-funds 5

5 I do not invest in Europe 5

0 Other 0

0 10 20 30 40 50 60 70 80 90

Percentage of Respondents (%)

Overall Respondents European Respondents

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

China remains the top Asian geography of interest among all parties; interest rebounded from only 38% in 2014’s survey to 50% this year.

The biggest differences between Asian respondents and overall respondents is a much greater interest in Japan, driven by the fact that a large number of Japanese investors responded to the survey.

In addition, Asian investors are much more interested in Indonesia than other respondents and are much less interested in India.

Table II highlights how investor interest within the Asian market changed over the last ten years.

In 2007, China, India, and Japan enjoyed nearly equal investor interest. Since then, interest in both India and Japan has stagnated (though interest in both actually increased significantly since last year) while interest in China has surged.

Interest in Southeast Asian funds has only become substantial over the last five years, driven in part by investors’ desire to diversify away from China exposure.

There are still a number of investors who do not invest in Asia — “I do not invest in Asia” would have been the sixth ranked answer in 2016 with 15% of responses.

Table II Which Geographies in Asia Are of the Most Interest? Top Four Response:

2007 2016

Country/Region % Targeting Country/Region % Targeting China 28% China 50%

India 28% Southeast Asia 27%

Japan 25% India 26%

I do not invest in Asia 25% Japan 19%

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2007 Survey and 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 20 Chart XV Most Attractive Asian Markets For Asian country-focused funds, I find the most attractive markets to be (choose no more than three):

50 China 46 27 Southeast Asia 23 26 India 12 19 Japan 38 14 Australia 15 12 South Korea 4 4 Indonesia 12 2 Vietnam 0 0 Taiwan 0 17 I only invest via Pan-Asian funds 15 5 I only invest via fund-of-funds 4 7 I only invest via global funds 4 15 I do not invest in Asia 4 1 Other 0

0 10 20 30 40 50 60

Percentage of Respondents (%)

Overall Respondents Asian/Australian/Middle Eastern Respondents

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

China continues to lead investor interest by a wide margin, thought interest in India increased significantly, bringing it into second place, driven by hopes that “Interest in Brazil the new government will be increasingly friendly to business (Chart XVI). fell noticeably Interest in Brazil fell noticeably in the past year amid economic difficulties and political turmoil. in the past year

With difficulties in Brazil, a number of investors have been looking to diversify amid economic their exposure; interest in Pan-Latin American funds remained strong and there was increased interest in Peru and Mexico as well. difficulties and political turmoil.” Elsewhere in Asia, there was a notable increase in interest in South Korea as well as a large decline in interest in Indonesia.

Interest in Russia, the other BRIC country in our survey, remained very weak as the Ukrainian crisis and political conflict with the West continued to play out.

Though there has been a lot of talk about sub-Saharan Africa as the latest “hot” emerging market, interest in our survey remained stable from last year at 6%.

The number of respondents stating that they did not invest in emerging markets continued its three-year decline, falling from 32% in 2014 to 25% in 2015 and finally 16% this year.

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 22 Chart XVI Most Attractive Emerging Markets Which emerging markets do you find most attractive (choose no more than four):

47 China 44 23 India 15 21 Pan-Asia 13 20 South Korea 7 19 Southeast Asia 14 16 Brazil 22 15 Pan-Latin America 16 8 Indonesia 15 8 Mexico 6 7 Peru 3 6 Central Europe (Poland, Czech Republic, Hungary, etc.) 10 6 Sub-Saharan Africa 6 5 Colombia 8 5 Vietnam 5 4 Turkey 8 4 Middle East/North Africa 3

South Africa 3

3 Chile 1

Eastern Europe (Russia, Ukraine, Georgia, etc.) 1 2 1 Russia 0 5 I only invest via global emerging market funds 2 5 I only invest via emerging market funds-of-funds 3 16 I do not invest in emerging markets 25 2 Other 0

0 5 10 15 20 25 30 35 40 45 50 Percentage of Respondents (%)

2016 2015

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey Note: South Africa was added for the first time to the Survey this year, we have no data for 2015 © 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 23 The prospect of strong long-term economic growth that could positively impact returns drove investor interest in emerging markets. However, the number of respondents who felt compelled to invest in emerging markets on that theory dropped from 77% four years ago to 54% (Chart XVII).

As it was last year, a desire to diversify their private equity portfolio was the second most popular reason to invest in emerging markets.

The primary reason investors do not invest in emerging markets is their perception that the risk/return profile in developed markets is more attractive — a perception that has remained the same over the last three years (Chart XVIII).

Chart XVII Interest in Emerging Market Private Equity My interest in emerging market private equity is driven by (check all that apply):

Strong long-term economic growth 54 in a number of these countries Desire to diversify my private equity portfolio by geography 33 to achieve benefits of lack of correlation I am less interested in emerging markets in general than in 16 exposure to a few specific countries with large opportunities Lower forecast returns in the established markets of private 12 equity make this sector relatively more attractive As an institutional investor from an emerging market, 2 I am looking to support my home markets

Other 4

0 10 20 30 40 50 60

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 24 Chart XVIII Disinterest in Emerging Market Private Equity For those not interested in emerging markets, I am not interested because (check all that apply):

I find the risk/return profile in developed 55 markets more attractive

I am uncomfortable with the degree of political, 32 currency, or economic risk in emerging markets

These markets are not developed enough and it is difficult to find experienced 26 managers with strong track records I am not staffed properly to perform due diligence on these markets that basically offer emerging 26 manager risk as well as emerging markets risks As an organization, we are satisfied to get emerging markets exposure through 19 publicly-traded securities My private equity program is relatively new, and we are focused on building exposure in 6 our core, home markets before diversifying

Other 10

0 10 20 30 40 50 60

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Fund managers in the large, homogeneous U.S. market are predominantly differentiated by investment strategies rather than geographic differences.

The majority of respondents indicated a strong preference for funds that generated returns via operational improvements and were staffed with operating professionals. This is consistent not only with past survey results but also across all investor types (Chart XIX).

There is a strong interest in buy-and-build strategies, with the least interest being for regionally-focused funds.

As far as industry sector-focused funds, both healthcare and technology are the biggest areas of focus, though 31% of respondents simply target strong track records (Chart XX).

Both European and Asian respondents are more interested in retail/consumer strategies, and Asian respondents are much less interested in energy funds.

Within the energy sector, an area with a wide diversity of strategies, midstream oil and gas funds and diversified funds attract the most interest, though North American respondents are more focused on upstream strategies (Chart XXI).

Chart XIX Most Attractive U.S. Middle-Market Sectors Which 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 79 staffed with professionals with operating backgrounds

Funds focused on buy-and-build strategies 63

Restructuring/turnaround funds 40

Funds focused on single industries 37 (i.e., energy, retail, healthcare, media) Funds focused on growth companies, often 31 investing without majority control

Regionally-focused funds 18

Strategy is irrelevant, a demonstrable superior 22 track record is my only concern

I only invest via funds-of-funds 0

I do not invest in the U.S. middle market 8

Other 0

0 20 40 60 80

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 26 Chart XX Interest in Industry-Focused Funds As far as funds focused on single industries, I am most interested in (choose no more than three):

Healthcare 43

Technology 41

Energy 30

Retail/Consumer 27

Financial services 12

Media/Telecommunications 10

Agribusiness 3

Industry is irrelevant, I simply focus on the best managers 31

I do not invest in industry-focused funds 10

Other 3

0 10 20 30 40 50

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Chart XXI Interest in Sectors within Energy In the energy sector, I am most interested in (choose no more than three):

Midstream oil and gas funds 37

Diversified funds with broad mandates 33

Upstream oil and gas funds 30

Energy/power infrastructure funds 15

Distressed energy funds 15

Renewable energy funds 8

Energy debt funds 5

I do not invest in funds focused on energy 30

Other 3

0 10 20 30 40

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Investor interest in technology only funds decreased somewhat from 29% last year to 21% this year, while interest in cleantech only funds has continued to “Endowments dwindle to a very low level (Chart XXII). and foundations Endowments and foundations remain much more active in venture capital than other investors and focused on early stage investments, with 57% of those remain much more respondents targeting that stage. active in venture Since 2007, the number of respondents not investing in venture capital has capital than other more than doubled, from 17% then to 37% now — though this year it noticeably improved from 42% saying they did not invest in the sector in 2014. investors.”

European investors are the most negative on the sector, with 46% of respondents saying they do not invest in venture capital at all, though Asian/Australian/ Middle Eastern investors were not far behind at 42%; North American investors were more positive, with only 30% not targeting venture capital.

Chart XXII Most Attractive Venture Capital Sectors In venture capital, I focus on funds active in the following sectors or stages (choose all that apply):

Funds investing in multiple sectors 19

Technology only funds 21

Life science only funds 16

Cleantech only funds 2

Venture debt funds 3

Multi-stage 25

Late stage 24

Mid-stage 25

Early stage 43

Seed stage 20

I am focused solely on historic returns 5

I only invest via fund-of-funds 5

I do not invest in venture capital 37

Other 0

0 10 20 30 40 50

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

There are several distinct distressed strategies, but many fund managers pursue a combination of these approaches within the same fund.

Most respondents prefer strategies with a value-added focus that generate higher multiples of return. In all our previous surveys, restructuring/turnaround funds and distressed debt for control funds have switched back and forth for the lead in the sector (Chart XXIII).

For the first time this year we asked investors about their interest in special situations funds; there was strong interest in these funds across geographies and they were actually the leading distressed strategy for European investors with 62% of them targeting it.

Opportunistic credit funds (with a strong focus on assets other than corporate debt) are another area of focus for investors. While some investors have expanded their distressed debt category to include opportunistic credit, others consider it a straight credit or fixed income product, and therefore is not included in their alternatives allocation.

Chart XXIII Distressed Investments Within the distressed debt/restructuring sector, I am most interested in (choose no more than two):

Distressed debt for control 48 funds (loan-to-own) Restructuring/turnaround funds 44 (focused on equity, not debt)

Special situations funds (usually 43 combining debt and equity) Opportunistic credit (mispriced 30 debt, small loan portfolios, etc.) Distressed debt: active/non-control funds 18 (often hold through restructuring)

Distressed debt trading funds 14

Distressed debt hedge funds 3

I do not invest in this sector 12

Other 0

0 10 20 30 40 50

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Over the past four years, investors have been increasingly focused on the private credit sector as they look at opportunities created by the strained bank markets.

Respondents to the survey are more focused on the mezzanine, opportunistic credit, and senior credit sectors, though a number of investors make their commitments to these strategies outside their private equity allocations (Chart XXIV).

Among this year’s respondents, North American investors are more likely to invest in senior debt out of their private equity allocations with 35% doing so, while 50% of insurance company respondents invest in mezzanine through their private equity allocations.

Few respondents to the survey were interested in Business Development Companies (“BDCs”) or other publicly listed vehicles.

Chart XXIV Credit In the credit sector, my firm:

100 39 40 88 35

18 11 60 11 16 29 13 40 40 39 Percentage of Respondents (%) of Respondents Percentage 20 21 5 6 0 5 Mezzanine Senior Debt BDCs/Publicly Listed Opportunistic Credit

Invests as part of private equity allocation Invests but not as part of a private equity allocation Is considering investing in this sector Does not invest in the sector at all

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey Note: Some sectors total greater than 100% as a few investors had multiple responses

Interest in real assets has been growing among sovereign wealth funds and pension plans with significant long-term liabilities and a desire to pursue strategies that could be resilient in times of high inflation.

Oil and gas was the only sector that attracted strong interest where the bulk of the investments made were coming from private equity allocations, though those investing in oil and gas through private equity allocations dropped from 49% last year to 34% this year (Chart XXV).

However, the other sectors also attracted interest from general real asset, inflation hedging allocations, or from specific allocations in sectors such as infrastructure or timber.

Large investors (those seeking to commit $500 million or more to private equity in 2016) are much more interested in real assets, while family offices are much less interested in the sector.

Chart XXV Real Assets In the real asset sector, my firm:

100 49 40 64 63 54 74

60 13 3 16 37 14 40 11 11 34 26 22 16 11 Percentage of Respondents (%) of Respondents Percentage 20 10 13 11 7 7 0 6 Oil & Gas Infrastructure Metals & Mining Agricultural Timber Ships or Aircraft Farmland

Invests as part of private equity allocation Invests but not as part of a private equity allocation Is considering investing in this sector Does not invest in the sector at all

Source: Probitas Partners’ Infrastructure Institutional Investor Trends for 2016 Survey Note: Some sectors total greater than 100% as a few investors had multiple responses

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 31 Secondary Market The number of investors who are active in key areas of the secondary market “The number of increased this year; those purchasing direct positions decreased from 50% last year to 41% this year, while those investing in secondary funds decreased from investors who 49% last year to 40% this year (Chart XXVI). have sold or However, the number of investors who have sold or are considering selling positions in the secondary market has risen to an all-time high of 40%, up from are considering 31% last year; among North American respondents, 50% look to be active in selling funds. selling positions in the secondary For the first time this year we asked whether investors actively invested in fund restructurings through secondaries; 17% of overall respondents, and 21% of just market has risen North Americans did so. to an all-time

Chart XXVI Secondary Market Investments high of 40%” In the secondary market, my firm (choose all that apply):

Actively invests in secondary funds 41

Actively purchases direct positions 40 in funds in the secondary market

Has sold or is considering selling funds in our 40 portfolio for portfolio management purposes

Actively invests in fund restructurings 17 through secondaries

Provides advice to clients on secondaries 15

Actively purchases direct positions in 13 companies in the secondary market

Is not active in secondaries in any manner 19

Other 6

0 10 20 30 40 50

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Interest in co-investments remained relatively consistent over the last year, with large investors who often have more resources to deploy being more active (Chart XXVII).

Only 6% of large investors said that they did not pursue co-investments or direct investments at all.

Family offices are more likely to invest directly in companies, with 50% of them targeting that strategy.

Chart XXVII Directs and Co-Investments Regarding directs and co-investments, my firm (choose all that apply):

46 Has an active internal co-investment program 58 25 Only opportunistically pursues co-investments 19

Provides advice to clients on co-investment 16 or direct investments 26 14 Invests directly in companies 10

Requires or prefers a co-investment as a 12 means of diligencing a new fund manager 19

Has an outsourced co-investment program 5 3 Does not invest in co-investments 18 nor directly invests in companies 6 4 Other 3

0 10 20 30 40 50 60

Percentage of Respondents (%)

All Respondents Large Investors

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey Note: “Large Investors” denotes those survey respondents who plan to commit $500 million or more to private equity in 2016

As with most of our past surveys, the level of general partner financial commitment to a fund remains the most important term for investors as it is a key factor in “None of the assuring alignment of interest between limited partners and general partners (Chart XXVIII), with the overall level of management fees closely behind. Asian/Australian/

Though there is a degree of commonality in the issues investors focus on, there Middle Eastern are distinct differences as well; Chart XXIX compares the responses of European respondents to Asian/Australian/Middle Eastern respondents to provide respondents an example. targeted ESG As far as strict adherence to the ILPA Principles or the inclusion of a strong policies as an Environmental, Social and Governance (“ESG”) policy, both of which are frequently discussed, neither of these issues ranked highly, though responses issue of focus varied tremendously: [while] 35% 33% of pension plan respondents targeted strict ILPA compliance and 25% were focused on strong ESG policies; of European

None of the family office respondents were focused on strict ILPA compliance; respondents felt that strong ESG 35% of European respondents felt that strong ESG policies were important while 15% felt strict compliance with the ILPA Principles were important; policies were For North Americans, 15% thought strict adherence to the ILPA Principles was important.” important while only 7% felt strong ESG policies should be targeted;

None of the Asian/Australian/Middle Eastern respondents targeted ESG policies as an issue of focus and only 8% felt that strict ILPA compliance was important.

In past surveys we asked investors in more detail about the ILPA Principles and found that, though few investors insisted on strict compliance, a majority of investors of all types used them as a starting point for terms negotiations.

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 34 Chart XXVIII Issues Regarding Fund Structure The 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 four):

Level of general partner financial 62 commitment to the fund

Overall level of management fees 55

Distribution of carried interest between 47 the senior investment professionals

Structure or inclusion of a key man provision 44

Cap on fund size 40

Carry distribution waterfalls 36

Ownership of the management company 35

Transaction fee splits 31

Level of carried interest 29

Structure or inclusion of a 13 no-fault divorce clause

Strict adherence to the ILPA Principles 13

Sharing of carry and/or investment decision 12 making with a third-party sponsor Inclusion of a strong Environmental, 10 Social, and Governance policy

Other 2

0 10 20 30 40 50 60 70

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 35 Chart XXIX Issues Regarding Fund Structure: European Respondents vs. Asian/Australian/Middle Eastern Respondents The issues I focus on most as far as terms or structure of a fund are (choose no more than four):

Level of general partner financial 70 commitment to the fund 54 65 Overall level of management fees 58 50 Carry distribution waterfalls 23 50 Cap on fund size 31 Distribution of carried interest between 40 the senior investment professionals 27 40 Structure or inclusion of a key man clause 42 35 Transaction fee splits 23 Inclusion of a strong Environmental, 35 Social, and Governance policy 0 30 Ownership of the Management Company 23 15 Strict adherence to the ILPA Principles 8 Sharing of carry and/or investment decision 10 making with a third-party sponsor 15 10 Level of carried interest 35 Structure or inclusion of a 5 no-fault divorce clause 8 0 Other 0

0 20 40 60 80

Percentage of Respondents (%)

European Respondents Asian/Australian/Middle Eastern Respondents

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

The greatest fear of most private equity investors was their perception that too much money was coming into all areas of private equity, followed very closely by the concern that the private equity market feels like it is at the top of the cycle (Chart XXX).

Concerns that the market may be at the top of a cycle — with the resulting risk of a decline in the offing — was actually the greatest fear of insurance companies (79%), large investors (56%), and Europeans (56%).

Even though middle-market buyouts in North America and Europe were by far the area of strongest interest for investors, the third-ranked fear of investors, at 41%, was that purchase price multiples for middle-market buyouts are too high and threaten future returns. This was actually the number one concern of North American investors, 54% of whom selected it.

Venture capital is a smaller section of most investors’ portfolios, but it is notable that fears particular to the sector — that another technology bubble is forming, or that access to top quartile managers is too difficult and new managers are unattractive — are very low. However, among endowments and foundations who tend to have a larger exposure to venture capital, their third-ranked fear was that another technology bubble is forming, with 37% of them mentioning that.

A number of investors submitted their own concerns under the “Other” category; a selection of those responses are detailed below:

Lack of transparency for portfolio company fees charged by general partners.

The industry has been relatively disciplined compared with 2007–2008. However, the buildup of “dry powder” and increasing fund sizes will inevitably change that since the money has to be invested at some point. The impact of future rate rises on the industry is untested.

Fees (management fees and carry) are compressing returns to limited partners, making the asset class less desirable versus public market alternatives.

© 2015 Probitas Partners Private Equity Institutional Investor Trends for 2016 Survey 37 Chart XXX Greatest Fears Regarding the Private Equity Market My three greatest fears regarding the private equity market at the moment are:

Too much money is pursuing too few attractive opportunities 51 across all areas of private equity

The current private equity market feels like we are at the top of the cycle 49

Purchase price multiples in middle-market buyouts are 41 too high and threaten future returns

Purchase price multiples in large-market buyouts are 33 too high and threaten future returns

Management fee levels and transaction fees on large funds are destroying 28 alignment of interest between fund managers and investors

Large firms in the market are becoming generalized asset 25 managers and moving away from key investment strengths

Private equity is most effective as a niche market and too much 19 money is being raised in all private equity sectors

Increased competition among limited partners is 13 limiting my access to co-investments

Generational transitions at a number of long-lived firms are generating 12 concern about those firm’s future success

Too much money pursuing too few experienced private equity 12 professionals in the hot emerging markets

Another technology bubble is in the process of forming 11

Access to top quartile venture capital managers is impossible without 9 previous relationships, and new managers are unattractive

We do not have adequate staff in place to 6 deal with issues in my current portfolio

The number of funds in my portfolio is too 5 large for my firm to effectively monitor

My current strategy prevents me from pursuing interesting 4 opportunities in the private credit sector

I find myself increasingly at odds with other limited 3 partners due to preferential treatment

Given central bank policies, I am not sure there will ever 2 be a wave of distressed opportunities

Decreased leverage availability will hurt companies 1 needing working capital or re-financing

Other 4

0 10 20 30 40 50 60

Percentage of Respondents (%)

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2016 Survey

Private Equity Institutional Investor Trends for 2016 Survey © 2015 Probitas Partners 38 Table III highlights investors’ concerns pre-Global Financial Crisis and compares them to their fears going into 2016.

Concerns about too much money coming into the market were among the top issues in both 2007 and 2016. In 2007 investors were very aware that there was too much debt and too much equity available in the buyout market and that the strong returns leading up to 2007 and beyond were unlikely to continue.

Investors are now concerned that purchase price multiples for middle-market buyouts are too high and that we are at the top of a market cycle — leading to concerns for future returns.

In the 2016 survey, a quarter of respondents were concerned that large firms in the market were becoming asset managers focused on growing assets under management and were moving away from their key investment strengths — an issue that was not topical in 2007.

Table III What Keeps You Up at Night? Top four responses:

2007 2016

Issue % Targeting Issue % Targeting Management fee levels and transaction Too much money is pursuing too few fees on large funds are destroying 51% attractive opportunities across all areas of 51% alignment of interest between fund private equity managers and investors The amount of leverage in the buyout market is unsustainable, and over the The current private equity market feels like 48% 49% next two years credit problems will hurt it is at the top of the cycle performance of recent vintage funds There is too much money available in Purchase price multiples in middle-market the large buyout market and this will 39% buyouts are too high and threaten future 41% dramatically impact future returns returns Private equity is most effective as a niche Purchase price multiples in large-market market and too much money is being 35% buyouts are too high and threaten 33% raised in all sectors of private equity future returns

Source: Probitas Partners’ Private Equity Institutional Investor Trends for 2007 Survey and 2016 Survey

Several key trends for 2016 emanate from the survey and our ongoing conversations with investors:

The dramatic increase in private equity “dry powder” threatens future returns and nearer term fundraising. Chart XXXI shows just how swiftly private equity “dry powder” has built up over the last two and a half years, especially for funds targeting North America. In a market already burdened by high purchase prices, these levels of “dry powder” put more pressure on fund managers to put capital to work at what is likely the peak of the market cycle.

Separate accounts are becoming increasingly important to large investors — and the amounts raised through these accounts are more opaque then those raised for multi-party vehicles. Separate accounts — either specifically targeted at a particular strategy or giving the manager wide latitude to invest across strategies — are becoming increasingly important to very large investors, not only as a method to reduce manager costs but also as a way to effectively deploy large sums in capital- intensive sectors such as large buyouts and infrastructure. Commitments made to these accounts — and the “dry powder” that they engender — are much more difficult to track than multiparty vehicles.

Smaller investors and the “best of breed” approach. Many smaller, sophisticated investors continue to take a targeted approach, focusing on “best of breed” managers in narrower strategies looking to generate alpha in inefficient sectors such as middle-market industry-focused buyout, growth capital funds, middle-market distressed, and turnaround vehicles. This approach often requires both looking at new managers and moving away from established relationships with managers who these limited partners perceive as having become too large for their strategies. However, these strategies are not immune to the impacts of the dramatic increase in “dry powder.”

Private debt funds and the credit cycle. Private debt funds — in private equity, real estate, and infrastructure — have grown tremendously in interest since the Global Financial Crisis driven by changes in the regulatory environment. This growth has resulted in the formation of a number of new funds, some of which are run by managers with little experience investing across credit cycles.

At the large end of the deal market, sovereign wealth funds and the largest public pension plans are increasingly competing with fund managers for deals. These institutions are becoming increasingly sophisticated direct investors, and they often have longer-term investment horizons and a lower cost of capital than many funds, giving them unique advantages in certain circumstances. A number of them are also willing to join direct investment syndicates for particular deals — making them both competitors and partners to fund managers.

Unicorns may indeed be mythical creatures. Talk of Unicorns — venture capital backed private companies with valuations of $1 billion or more — has been a leading topic of discussion in venture capital circles over the last year as these mythical creatures seemed to become more plentiful. However, a turbulent IPO market has increased skepticism over the private valuations of many of these companies, a trend likely to dampen euphoria that was building earlier this year.

800 700 600 500 400 300 USD in billions 200 100 0 Jul-13 Jul-08 Jun-11 Jan-11 Feb-13 Apr-12 Jun-06 Sep-12 Apr-07 Jan-06 Oct-14 Sep-07 Feb-08 Oct-09 Oct-04 Dec-13 Aug-15 Dec-03 Dec-08 Nov-11 Aug-10 Aug-05 Mar-15 Mar-10 Nov-06 Mar-05 May-14 May-09 May-04

North America Europe Asia Rest of World

Source: PREQIN

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