Private equity fund raising trends.

One of the major obstacles facing PE firms trying to attract money from individual investors is the question of liquidity and diversification. Compared to institutions, individuals really like to get their money if they need it. According to the WSJ article, Blackstone has obliged them with a new fund it launched in January, Blackstone Private Equity Strategies (BXPE), which has pulled in some $6 billion so far.

Quarterly redemptions are allowed. But that means the fund needs consistent returns, which means avoiding long accumulations of dry powder. So far, BXPE has approached the problem by taking a wide mix of positions in other Blackstone PE deals, and even deals from outside firms.The fund has made returns of 9.2% through September, but the article reports there have been questions as to whether the strategy’s exposure to outside deals will prove as profitable as the deals from within Blackstone, because the prices the fund is paying for those outside positions seem high.

Blackstone’s expectations for BXPE remain lofty. The firm reportedly believes the fund could grow as large as its individual-based private credit and real estate funds, which have $36 billion and $55 billion in net-asset value, respectively. As PE firms continue efforts to crack the individual market as a source of new AUM growth, expect to see a range of approaches as well as trial and error in response to any strategies that don’t work out as intended.

Reportedly, $12-$13 trillion is sitting in Americans’ 401K plans. Traditionally these funds have been restricted to public investments such as mutual funds or index funds managed by a financial services advisory group like Vanguard.

But many in the private equity industry hope a second Trump administration may change that by allowing holders of tax-deferred 401K retirement plans to access an array of private investments such as leveraged buyouts and private loans. According to this Financial Times piece, private equity lobbyists plan to “hit the ground running” in terms of getting the new administration to consider the rule change.

The traditional view has been that these less regulated spaces were simply too opaque and risky for small investors to safely evaluate and negotiate. But that also denies smaller investors a chance for the more lucrative returns and diversification that private markets offer, something large and institutional investors have been taking advantage of for years. The change would also offer PE firms the chance to tap a huge new pool of investment dollars while potentially kicking off a new round of growth for the space.

Marc Rowan, CEO of asset manager Apollo Global Management, stated the case for the change in terms of diversification: “I jokingly say sometimes, we levered the entire retirement of America to Nvidia’s performance. It just doesn’t seem smart. We’re going to fix this and we are in the process of fixing it.”

Private equity continues to evolve, and as the number of PE firms appears to continue to grow, I thought this quote from the Economist made for an interesting introduction to the fund landscape:

According to Preqin, a London-based research house, there were 24 private-equity firms in 1980. In 2015 there were 6,628, of which 620 were founded that year (see chart 2). Such expansion looks all the more striking when you consider what has been happening elsewhere in business and finance. In America, for which there are good data, the number of banks peaked in 1984; of mutual funds in 2001; companies in 2008; and hedge funds, probably, in 2015. Venture-capital companies are still multiplying; but they are effectively just private equity for fledglings.

The proliferation of funds and fundless sponsors pursuing the lower-middle-market (businesses with revenue ranging from $10M to $200M) has caused me to wonder how the preferred rate of return will fare. I am specifically interested as it relates do deals of this scale not only because it is the space I look at most, but also because in this space the sponsor relies more on the “20” in the 2 and 20 model than the “2.” I have personally always thought that it was best to stay small in private equity, and seek multiple arbitrage opportunities, or work for the largest fund you can, and secure stable income. I was surprised to see that in at least one instance, the pref. return for LPs has been removed:

“High-performing GPs have been taking advantage of sterling market conditions to negotiate more favorable terms with LPs. Some have broken convention for hurdle rate, the minimum rate of return for a fund required before the manager begins taking carry. CVC reportedly plans a hurdle rate of 6% for its Fund VII, compared with the industry standard of 8%. Advent International removed the hurdle rate outright from its latest fund, which closed on $13 billion, though that decision was offset somewhat by the fund’s switch to the more LP-friendly European waterfall structure.”

The paper makes clear that this is not the case for PE firms that don’t operate in the “rarified upper atmostphere,” and that continued fund-raising success relies on well-crafted and highly detailed investment strategies:

“As it gets harder to find good deals at the right price and to generate great returns, PE firms that have pulled off that feat—and that are able to communicate succinctly how they use insights from past deals to generate great returns in the future—will have an edge in pulling in capital.”

McKinsey & Company released its annual review of private markets: The Rise and Rise of Private Equity. What I found most interesting, as it relates to private equity, is that a disproportionate amount of the funds raised are in the so called “mega fund” category. This category excluded, private equity fundraising efforts would have otherwise been down for the year.

I have included a few excerpts from the report (emphasis added):

“Private asset managers raised a record sum of nearly $750 billion globally, extending a cycle that began eight years ago.”

“Within this tide of capital, one trend stands out: the surge of megafunds (of more than $5 billion), especially in the United States, and particularly in buyouts.”

“Median PE EBITDA multiples in 2017 exceeded 10 times, a decade high and up from 9.2 times in 2016.”

“It was a record year for fundraising, but growth was overwhelmingly concentrated in just one region, sub-asset class, and fund size: US buyout megafunds. Indeed, if growth in these funds had been flat versus 2016, overall fundraising would have fallen by 4 percent. Megafunds now account for 15 percent of total fund raising, up from 7 percent in 2016, having exceeded their previous peak of 14 percent in 2007.”

I highly recommend this report to any private equity practitioner. Please see the link below.