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Private equity

UBS View
Prefer small-/mid-cap buyouts in US/emerging markets; distressed debt in Europe

• Global M&A volume has continued its downward trend since Q4 2010, falling by -20% quarter-by-quarter in Q3 2012, with a drastic decline in Europe of -46%, the third lowest quarter since 2001. However, private equity withstood the negative M&A environment as global activity grew by +13% in Q3, and the US posted its strongest quarter since Q3 2007. The importance of private equity in emerging markets continues to grow, now accounting for 13% of global activity, strongly driven by Asia, but increasingly also by Africa.
• We prefer buyout strategies in North America, given reasonable valuations, liquid debt markets and our house view of economic outperformance vs. Europe. Emerging markets offer compelling opportunities for PE investors, especially outside the main hubs (China, Brazil), which have become expensive. Distressed strategies which focus on acquiring complex/illiquid loan positions from banks in Europe are also attractive.

↗ Positive scenario
Prefer small-/mid-cap buyout and secondaries
• An abating Eurozone debt crisis and improved business confidence would increase deal flow and exit opportunities for private equity managers, but would also increase entry prices. In such a positive scenario, we would perceive commitment strategies to secondary funds as attractive for building exposure to an invested private equity portfolio.

↘ Negative scenario
Prefer distressed debt
• A renewed escalation of the debt crisis would significantly impact deal activity, the availability of debt and company owners' willingness to sell. At the same time, it would offer even more attractive opportunities within distressed strategies and lower entry prices for long-term private equity investors.
Note: Scenarios refer to global economic scenarios (see slide 7)

Recommendations
Strategic (1 to 2 years)
• In Europe, the ongoing deleveraging has led to attractive opportunities for special situations. We thus recommend pursuing less liquid investment strategies with a preference for debt to benefit from the macroeconomic adjustment process and selling pressure for many European banks.
• We prefer small-/mid-cap buyouts in North America given the better economic outlook vs. Europe, higher transaction certainty and more attractive entry prices.
• Investors looking for downside protection during economic uncertainty can consider large-cap buyouts in the US, which offer exposure to large, diversified companies at more attractive prices and are supported by liquid debt markets.
• We advise investors make an ongoing allocation to private equity in emerging markets, which offer an attractive way to capture superior long-term growth and gain access to small-/mid-cap companies unavailable on the stock market.

What we're watching
Credit markets

Why it matters
In H1 2012, leveraged loan issuance, an important ingredient of PE activity, dropped 17% y/y in the US, but over 41% in Europe. The US debt market is much deeper than Europe, raising over EUR 153bn of leveraged debt, while Europe achieved only EUR 16bn in 1H 12 at less attractive conditions.

Exit activity
Exit activity is an important indicator for the health of the PE market and a key return driver for investors. Despite the difficult macro environment, distributions from portfolio sales (USD 69bn) have held up, and grew 20% yoy.

Sector activity
Transactions in consumer discretionary and in energy & utilities remain the most preferred sectors for private equity investors in 2012.

The US has seen its strongest quarter since Q3 2007, while sentiment in Europe remains weak
[Chart showing USD billions from Q1 2010 to Q3 2012]
Source: S&P, UBS CIO, as of October 2012
Note: Past performance is not an indication of future returns.

UBS
For further information please contact CIO's asset class specialist Stefan Brägger, stefan.braegger@ubs.com
Please see important disclaimer and disclosures at the end of the document. 41
Note: We emphasize the equal importance of fund manager selection and the commitment strategy. Please note that private equity is an illiquid asset class and must be held at least until the end of the fund (10+ years).
Please note that UBS might not have a product available which reflects our UBS CIO private equity recommendations. Private equity is only suitable for qualified investors (> USD 5m investable assets).

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