Private equity funds have significantly grown in number, size and significance in the last 20 years.
Recent high-profile acquisitions include a stake in the Manchester City soccer team and the purchase by Ithaca Holdings, backed by private equity firms, of Taylor Swift’s recording catalog. Along with private equity’s growth, it has also become an area of political focus, sure to be a talking point during the next presidential election. Following are 15 key observations on the current state of private equity.
1. Private equity raises money from investors and invests that capital in different types of companies. The most common investment is a leveraged buyout, whereby a fund buys a majority stake in a company, attempts to improve it, and then sell the company for a profit. Private equity funds also invest in distressed assets, real estate, other funds and venture capital. Private equity funds raised approximately $700 billion in 2018. This broadly goes into several different categories. This amount raised is slightly less than in 2017.
2. Private equity as an asset class has matured greatly. Increasingly, to have broad equity exposure, investors must also have exposure to private companies. Along with diversification, private equity has historically (but see points below) offered the potential for returns that beat the public markets. Private equity investment continues to increase, with investments in around 8,000 + private companies. By contrast, the US public markets are shrinking. According to the New York Times, in the mid-1990s, there were more than 8,000 publicly traded companies, and by 2016, there were only 3,627.
3. As private equity funds have grown to be a larger part of the equity market, their returns have regressed closer and closer to the public markets. The largest funds are closer in returns to the public markets. According to a recent Wall Street Journal report, private-equity funds of $10 billion or more posted 14.4 percent five-year annualized returns net of fees as of the end of September 2018, barely edging past the 14.1 percent return for the S&P 500. See “Wall Street Journal “Private Equity Funds are Raising Bigger and Bigger Funds. They Don’t Often Deliver.”
4. Private equity have generally outperformed the public markets during periods of volatility. In 2018, where there was political and economic uncertainty, the average private equity fund appreciated 8.2 percent while public market indexes had double-digit declines. See, “10 Predictions for Private Equity for 2019” by Antoine Drean. However, the statistic may be misleading as private equity can choose not to exit investments in more challenging markets. Also, there is a large variety of returns in different private equity funds.
5. The spread of returns from high returns to very low returns among private equity funds is very large. See McKinsey “Return Dispersion is much Greater in Private Equity than in Public Markets.” This means it’s become increasingly difficult to find the right private equity fund to invest with. It also means that successful funds can outperform the median by a significant degree. However, it is hard to consistently be a successful fund.
6. The 5 biggest private equity funds are largely considered to be the following – The Carlye Group, Kohlberg Kravis Roberts (KKR), The Blackstone Group, Apollo Global Management and TPG. Each has more than $100 billion in assets under management. The CEO, Chairman and Co-Founder of the Blackstone Group recent authored “What it Takes– Lessons in the Pursuit of Excellence”. This book provides a good primer on private equity.
7. Private equity mega funds, those funds with $5 billion or more in pooled capital, take up a larger and larger part of the investment area. 19 mega funds were raised in 2018. These 19 funds reflected 20 percent of all private equity fundraising. See McKinsey and Co “Private Markets Come of Age.” The 2019 Preqin Global Private Equity and Venture Capital Report discusses the growing concentration of capital amongst a relatively small number of funds. It reported at the end of 2018, that 62 percent of the total capital raised was committed to the 50 largest funds.
8. According to Pitchbook, private equity fundraising in the US hit an all-time high in 2019. Pitchbook reports that as of the beginning of November 2019, US buyout funds raised north of $246 billion. According to a Fitch Ratings report, Private equity is sitting with approximately $2.1 trillion globally to invest. See “Private equity fundraising in the US hits all-time high” by Eliza Haverstock. This amount of “dry powder” is at an all-time high. See “This is the Biggest Year Ever for Private Equity Funding. Where are the Deals?” Dallas Business Journal.
9. Investors, economists and politicians are signaling the likelihood of a recession in the near future. With a huge amount of money to deploy, funds are developing strategies to deal with an economic downturn. This may mean less new deals and a focus on margins of existing investments.
10. Private debt funds have grown greatly and raised more than $100 billion a year for the last 4 years. According to Preqin, there are now 417 private debt funds in the market. The market for investing in private debt funds seems to be slowing some in 2019 with less on track to be raised than the last four years. See, e.g., Institutional Investor, “Investors are backing off from private debt”. Here, the article headlines that investors are backing off from the once booming asset class. Oct 10, 2019. The largest private debt funds are often closely connected to the largest private equity funds. These include GSO Capital Partners which is related to Blackstone, KKR, Ares Management, OakTree Capital Management and Goldman Sachs via its Goldman Sachs Merchant Banking Division. Pitchbook reports the following firms as leading the private debt market: Antares Management, Ares, Barings, TwinBrook Capital Partners, The Carlye Group, Midcap Financial, NXT Capital, BMO Financial Group, Madison Capital Funding, and Citizens Bank. See also Bloomberg, December 18, 2019, “Apollo and Blackstone are Stealing Wall Street’s Loans Business.” The movement to these behemoth funds also having large direct debt financing funds will have a big impact on the business of other traditional lenders and financing sources.
11. According to SPG Global, multiples for PE funded deals are averaging close to 11.5 times EBITDA. They attribute this to the sinking cost of debt, a mountain of private equity dry powder, and larger equity investments. The leverage on deals is overall close to 5.5 times EBIDTA. The multiples differ dramatically based on the size of the deal, the growth trajectory of the company, the assessment of risk of the company, and several other factors.
12. As private equity funds grow larger and have more capital to deploy, there are less club deals. According to McKinsey, “in 2007, 27 percent of megadeals included more than one large global GP. By 2018, that number was 4 percent. Club deals were associated with several notable investment catastrophes and largescale bankruptcies.” However, co-investments, where investors invest alongside a private equity fund, often without paying some of the usual fees, are continuing to increase. These deals are becoming increasingly competitive and provide an opportunity to reduce the exposure of investing in a single company.
13. Increasingly the largest private equity funds have grown their own operations teams and have more operating partners and executives than they used to. For example, Blackstone is reported to have more than 2,400 employees. Carlye has close to 1,600 employees. KKR has 1,300 employees. Funds are also investing in analytics and other technology to manage the fund and platform companies.
14. Funds are diversifying their fundraising and investment strategies in interesting ways. On the investment side, some of the largest funds are starting to raise funds from retail investors. On the investment side, there are now funds like Dyal Capital which has raised $9 billion to invest in other private equity funds.
15. The total volume of dollars going into private equity related deals is growing. However, the total number of deals transacted has been fairly flat the last few years. The average dollar volume per deal is increasing. According to Bain, the number of individual transactions in 2018 decreased by 13 percent, to 2,936 worldwide — but total buyout value jumped 10 percent to $582 billion (including add-on deals). See Bain, Global Private Equity Report 2019. A related trend is private equity funds selling their stakes in companies to other private equity funds in secondary transactions. This is different from years past where the normal exit was to a strategic buyer or to the public markets – this secondary market is anticipated to continue to grow. Increasingly the volume of deals done is driven by add on or bolt on transactions added to platforms.
