GLOBAL - Investing in private equity bears more risk as more money enters the market, the OECD has stated in its latest Financial Market Trends.
"The strong growth of capital available to private equity resulting from strong investor demand, together with readily available finance, increases the pressure to find new deals," writes Adrian Blundell-Wignall, deputy director in the OECD Directorate for Financial and Enterprise Affairs, in Financial Market Trends Nr. 92.
"This is driving down yields into line with (too low) interest rates. As this process continues it becomes more risky."
Blundell-Wignall pointed out "private equity plays a valuable role in helping transform under-performing companies."
But he stressed private equity companies have to ensure "leverage does not become too excessive and fair and reasonable rules of the game are adhered to".
The OECD deputy director explained this is especially important "at times when liquidity is plentiful in the global economy, and [interest] rates are too low". He suggests more transparency in deals and better cross-border self-regulation.
Increasing demand in private equity investment - also among pension funds - is not surprising for Blundell-Wignall given the "solid performance and the diversifying characteristics of private equity investment".
The growth of leveraged buy-outs (LBOs) is fed by an economic environment of low interest rates which set up an enormous arbitrage opportunity according to the OECD report.
One factor keeping "real interest rates unusually low for this stage of the cycle" is the "strong demand for long duration assets (in short supply) from pension funds for liability matching reasons," Blundell-Wignall found.
"A massive arbitrage opportunity is set up to borrow at low rates and buy higher yielding assets."