Investors pay up to join the private equity rush

The private equity boom has reached a level where investors are paying a premium for stakes in buyout funds managed by the industry’s biggest beasts, deploying billions of dollars into a hot market despite a mounting political backlash.

Investors such as endowments, private banks, insurers and sovereign wealth and pension funds are on course to trade a record amount of stakes in private equity funds this year. Some institutions are seizing on investor demand for an alternative to highly priced bonds and equities in order to flip their investments.

For the first time, stakes in big buyout funds are this year on average being sold at “par”, or equal, to their last public net asset value, according to Triago, a company that helps arrange the trades. These stakes have traded just shy of their NAV in recent years.

Funds managed by the best-known firms — such as Blackstone, KKR or Carlyle — are selling at a 5 per cent to 7 per cent premium over their NAVs, according to Antoine Dréan, Triago’s chairman.

“We are seeing a lot of buyers who don’t want a discount, they just want to get money to work,” he said in an interview. “If you just allocate money to a fund you often have to wait for a long time before it gets called, and it can kill your returns.” 

Reputable private equity firms tend to value their assets conservatively, to minimise volatility — a major attraction for institutional investors — and therefore often sell above the book value.

The ease of trading chunks of private equity funds has also improved. Aside from the ability to flip a stake at little or no discount, or even a premium, it can take just minutes to get a quote, according to Mr Dréan.

Institutional investors traded $60bn worth of private equity fund stakes in the first nine months of the year, and Triago forecasts that the full-year total will hit $90bn. That would mark a tenfold increase over the past decade and shatter last year’s $66bn record total. 

This growth mirrors the swelling size of the private equity industry. While the world’s mainstream equity markets have more than doubled in size since the turn of the millennium, this is only broadly on pace with the growth of the global economy. The private equity industry has expanded sixfold over the same time to about $2.5tn, according to State Street. 

A political backlash is also growing against the private equity sector, with research showing that buyouts of public companies lead to substantial lay-offs. The US Congress on Tuesday held a hearing called “America for Sale? An Examination of the Practices of Private Funds”, and Democrats — particularly presidential candidate Elizabeth Warren — are gunning for the industry.

The hearing sent “a definitive signal that private equity is the new financial bogeyman for Democrats both in Washington and on the campaign trail”, said Isaac Boltansky, an analyst at Compass Point, in a note.

Some analysts are worried that the private equity industry boom has become frothy, as institutional investors have flooded the sector with money in the hunt for juicy returns. Private equity firms have not been able to spend money as quickly as they have been able to raise it, leading to a mountain of “dry powder” building up in the industry.

“We believe that a decade of double-digit returns for private investment funds has ended,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, in a note. “High purchase valuations, all-time high leverage, deteriorating credit protections, falling interest coverage and nearly $2tn of dry powder suggest the best days are behind them.” She estimated that private equity funds would return less than 10 per cent annually in the coming years, far below the historical average. 

The growth of the buyout sector is only part of a wider boom in “private markets”, which includes property, untraded bespoke loans and infrastructure. These markets have grown 15 times, 18 times and 76 times respectively since 2000, but remain small compared with the private equity industry. 

Source: Financial Times

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