What do private equity firms and Oliver Twist have in common? They’re generally always hungry for more.
Apollo Global Management LLC is passing the hat around again, seeking to raise $20 billion by May for its newest global buyout fund. KKR & Co. this week wrapped up at $13.9 billion fund focused on North American buyouts, while other big-hitters including Blackstone Group LP, Silver Lake Partners and Vista Equity Partners are seeking $10 billion or more for their own flagship buyout funds. And then there’s Carlyle Group LP, which is attempting to raise $100 billion in four years.
These eye-popping figures come as the industry’s dry powder — the amount raised by firms that isn’t yet invested — hits new highs ($820 billion as of Dec. 31, according to Preqin).
The frenetic fundraising is possible because investors — predominantly pension funds, sovereign wealth funds and family offices — have been satisfied with the industry’s performance, often a bright spot compared to their overall returns. Case in point: during the 10 years through June 2016, private equity portfolios generated an annual return of 8.3 percent for public pension funds, beating equities, fixed income and other asset classes, according to Preqin.
Past isn’t necessarily prologue, though, and putting the money to work wisely will be a challenge. Today’s record valuations is making it that much more difficult for private equity funds to source new investments and could reasonably translate to lower returns for some deals invested in at these levels. But most funds have five years or more in which to invest the cash they’ve raised. Also, investors are buoyed by the fact that even though dry powder is hitting new records, the capital spent by firms has risen proportionately. Preqin data shows that the so-called capital overhang — or the amount of capital available to invest that exceeds what was spent the previous year — is actually close to where it stood in 2001.
The mountain of dry powder, however large, shouldn’t invite rashness: firms should take their time spending their cash and avoid investors whose checks come with terms that could misalign incentives. According to private equity advisory firm Triago, “a small but rising number” of investors have insisted on terms that encourage funds to spend their capital hastily based on the view that faster-than-average deployment improves returns. Such investors are offering to double their commitment if a fund can strike its first deal within a certain time frame or pushing for a fee haircut if no deal is struck within two years of a fund being raised.
But there’s no evidence that faster-than-average deployment enhances returns. Rather, returns are more closely tied to average purchase multiples — that is, in years when purchase price multiples were the lowest (such as 2001-2003 and 2009), returns were better-than-average, according to Cambridge Associates LLC.
Keeping that in mind, firms with newly refilled coffers should stay disciplined and seize opportunities in their own time. If they play their hands right, they’ll get to do it all again soon enough.