LP’s appetite for private equity in India

2023 marked the second-highest year for Indian Private Equity (PE) and Venture Capital (VC) fundraising, with a record ₹1.3 trillion raised across 102 funds. This set a new record for the number of funds raising capital in a single year, which prompts an exploration into the sources of this influx of capital.

Economic Growth and Investment Opportunities

India’s economic growth, driven by favourable factors such as a young demographic, rapid digitization, stable policies, and regulatory support, has set the stage for significant investment opportunities. Investments in startups have grown exponentially, with a 54% increase over the last five years. Of the approximately ₹14 trillion invested in Indian startups, about 40-50% comes from Alternative Investment Funds (AIFs). Indian private markets have also demonstrated resilience and an ability to absorb increasing amounts of capital while providing returns. Over the past five years, Indian private equity investments totaled ₹12.2 trillion, with exits reaching ₹7.6 trillion, indicating a healthy return on investment.

Private Equity’s Attractiveness

The prominence of private equity has grown significantly in the last decade due to its ability to generate continuous compound returns over long periods of time. The asset class has consistently demonstrated the ability to produce strong alpha over public markets and other asset classes. Globally, private equity has maintained a 4-6% premium over public markets like the S&P 500 over the last 22 years. In India, a CRISIL analysis of 217 funds with vintages from 2013 to 2022 showed that they outperformed the public market equivalent (S&P BSE Sensex TRI) by 13.5%.

Sources of Capital and Global Influence

Given the PE asset class’s outperformance, commitments to AIFs have increased tenfold since 2017, reaching ₹10 trillion as of December 2023. This capital comes from both domestic and international sources. Global funds are also increasing their allocation to India, with many deploying significant resources through both Indian and overseas entities. For instance, the International Finance Corporation invested over $3 billion in India in 2023, making India its largest single-country exposure.

Institutional Capital and Regulatory Support

Institutions like Pension Funds, Insurance companies, and endowments are among the biggest investors in private equity globally. Insurance companies contribute about 20% to the total global private equity assets under management (AUM), while pension funds contribute 25-35%. In India, life insurance companies can invest 3-5% of their assets in Cat 1 and 2 AIFs, compared to 5-10% allocations globally. However, none of the ₹35-40 trillion in Indian pension systems is currently allocated to private equity, which contrasts with other nations like Canada, where the Canadian Pension Plan Investment Board (CPPIB) allocates around 25% to private equity.

Family Offices to the Rescue

As private market opportunities expand, sophisticated Family Offices (FOs) in India are establishing separate teams for their private equity investments. However, most investors continue to favour fund-based investments due to the expertise, deep understanding, and sourcing advantages these funds offer. A McKinsey analysis revealed that direct private equity investments by high-net-worth individuals (HNIs) have decreased from 13% to 6% since 2021, while fund-based investments have increased from 8% to 10%.
Globally, HNIs and family offices allocate around 29% of total assets towards private assets, with a Camden survey indicating that 41% plan to increase their private portfolio exposure due to the prospect of superior long-term returns. In India, this allocation is estimated at 10-30%, indicating further room for growth.

Choosing the Right Fund Manager

The variation between the top and bottom quartiles of private equity funds is much higher than in other asset classes, and therefore, choosing the right PE manager is critical. Global data shows that the difference in returns between top and bottom quartile PE funds is about 19%, with the top quartile delivering 30% and the bottom quartile at 11.4%. Selecting the right fund manager can make the difference between significantly outperforming or underperforming benchmark returns in a portfolio.

Trends in Fundraising and Investor Insights

Our recent fundraising experiences and conversations with investors have revealed several emerging trends:
• The pool of domestic investors is expanding, with more HNIs looking to invest in private equity and more families setting up larger Family Office teams
• Experienced investors are seeking consolidation fewer trusted fund managers for more effective portfolio management
• Beyond its return track record, the team’s experience in understanding and investing in businesses, internal governance, and deep sectoral expertise play a crucial role in attracting investors
• While many investors use IRR (Internal Rate of Return) as a primary means of measuring fund performance, sophisticated investors evaluate performance based on a combination of three metrics: DPI (Distribution to Paid-In Capital), MoCC (Multiple on Committed Capital) and IRR (Internal Rate of Return)
• Co-investments are gaining popularity, especially with Family offices, as they offer investors the opportunity to increase returns by investing in handpicked businesses

The Road Ahead

Despite Private equity’s growth as an asset class, the industry still needs significant capital for further expansion . Our internal analysis indicates that India will require about ₹46 trillion in private equity capital over the next five years. A considerable portion of this will come from domestic sources as individuals, families, and institutions increase their capital pools, driven by the promise of attractive long-term returns in the Indian private market.
While the Indian PE/VC landscape has shown remarkable growth, much work remains in channelling institutional capital effectively to support continued expansion. Although the regulatory environment has been supportive, there is still a need for further efforts to bridge the gap between domestic and international allocation levels, enable investors to make informed choices in a complex and dynamic market.

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