– The Growing Importance of Low-Margin Separate Accounts
– Credit is Rapidly Becoming Big Business for PE
– Shadow Capital Piles Up
– Lexington Raises Record Secondary Market Fund
– PE Executives Say Returns are Falling Short of Targets
BLACKSTONE’S Q1 FUNDRAISING IS DOMINATED BY SEPARATE ACCOUNTS, indicative of the growing market share such vehicles are capturing. PE Hub reports that Blackstone, the world’s second largest manager of private equity funds behind Apollo, raised $30 billion for investments in the first quarter, while Tony James, the group’s president, said on an earnings call with journalists that a majority of the capital committed went to separate accounts. PE Hub also noted that Blackstone had raised $11 billion from individuals over the past 12 months. The rapid growth of relatively low-margin separate accounts and the growing importance of mechanisms that can effectively raise capital from individual investors are increasing competitive pressures for all but the biggest firms. Mid-sized and smaller PE firms are more reliant on higher-margin classic funds and may lack the resources to effectively tap individual investors.
CREDIT IS RAPIDLY BECOMING BIG BUSINESS FOR PRIVATE EQUITY. KKR is the latest firm to raise a high-profile direct lending fund, recently closing on $1.3 billion for the strategy, according to Bloomberg. Collected “in about a year,” the latest fund is three times the size of KKR’s initial $414 million direct lending pool, raised in 2011. That fund – seen as low-risk – is producing a 10 percent annualized net return. PE firms “are raising money to lend to companies as banks, hampered by heightened credit standards, scale back their operations.” While KKR gears up, other PE groups have raised tens-of-billions for credit strategies. Assets of Apollo’s credit funds have risen 68 percent in two years to $108.4 billion, while Blackstone currently manages $72.9 billion in debt strategies. Watch for newly launched credit funds to increase in size this year in response to regulations that have most recently caused banks to pull back from big deals with debt leverage equal to more than six times cash flow.
PRIVATE EQUITY’S SHADOW CAPITAL “CONTINUES TO PILE UP,” notes PE Hub, citing figures from global placement agent Triago. According to Triago estimates, “a whopping $113 billion in shadow capital was committed in 2014, a big addition to the post-crisis [fundraising] record of $438 billion raised by [classic] private equity funds last year.” Shadow capital consists of co-investments, separate accounts and direct investments. The first two forms of shadow capital are low-to-zero margin products for fund managers while direct investments bypass fund managers entirely. The quarterly, which contains a wealth of PE data, as well as analysis of trends, also reports that the typical PE fund sold on the secondary market in Q1 saw its price narrow 200 basis points to 96 percent of net asset value, with demand particularly strong for European funds, which are seen as bargains for dollar-based buyers in the wake of the euro’s fall. Triago says secondary volume is on pace to hit $38 billion in 2015, eclipsing last year’s $36 billion record.
LEXINGTON RAISES A RECORD $10.1 BILLION SECONDARY MARKET FUND. “The fund’s final tally blew past its $8 billion target,” attracting commitments “from more than 300 investors around the world,” writes Dow Jones’ LBO Wire. It “leaves Lexington well positioned to capitalize on what continues to be one of the most robust secondary investment environments to date.” The buying and selling of existing private equity fund stakes has come a long way from the occasional marketplace of decade ago, when the lion’s share of deals were thought to be discounted fire sales. Today, sellers use the secondaries market as an opportune tool for adjusting portfolio focus and concentration, while buyers have come to appreciate the low risk of mature funds and their rapid return of capital. “No sophisticated institutional investor today thinks about PE commitments as just ‘buy and hold,’” says Wilson Warren, a partner at Lexington.
PE EXECUTIVES SAY RETURNS ARE FALLING SHORT writes the Wall Street Journal, citing Deloitte & Touche’s Mergers and Acquisitions Trends Report 2015. At a time when the pace of realized private equity investments is close to historic peaks, some 96 percent of the 408 U.S. private equity executives polled by DT “said the exits they made fell short of targeted returns.” “Despite the vast volume of sales, return figures for the past two years have missed the mark for a substantial number of” private equity funds. “Barry Curtis, a partner at Deloitte M&A Services said in an email that the disappointment stemmed in part from ‘optimistic growth assumptions’ firms had about investments they made from funds raised following the financial crisis that began in 2007.” Slow global growth has not helped matters. As the WSJ says: the current exit market may be “biblical,” “but that doesn’t mean the returns are heavenly.”