Private equity is too big to ignore — for both investors and regulators.You can find EY's report on private equity here. Here are some interesting tidbits on EY's site concerning new avenues of growth for private equity:
“It’s critical,” said Peter Witte, associate director of Ernst & Young’s private equity group, in a phone interview. “If you’re not invested in private equity, or private capital, then you’re really missing out on where our economy is growing.”
Private equity firms now manage $3.4 trillion of investor commitments globally, up from less than $500 billion in 2000, according to a report, expected to be released Wednesday, from EY and the Kenan Institute of Private Enterprise at the University of North Carolina at Chapel Hill. Citing Preqin data, they said private capital assets have risen to $6 trillion, including infrastructure, real estate, private debt and natural resources.
At the same time, the pool of publicly traded companies in the U.S. has shrunk by almost half in the past 20 years, according to the report, which cited data from The World Bank. Companies backed by private equity firms employ almost nine million people in the U.S., the report shows, underscoring their broad and growing reach in the economy.
“We’re in a place now where private equity firms have a super abundance of capital,” said Witte. “As more capital flows into private equity, or private capital, there’s naturally going to be a more important role for regulators to play.”
Witte declined to comment on the private equity reform that Elizabeth Warren, the U.S. Senator and Democratic candidate for President, has proposed under the “Stop Wall Street Looting Act.” Warren announced the bill in July, raising concerns about the potential for bankruptcies and job losses when private equity firms load companies with debt to increase their returns.
Regulators could have a role in opening private equity to ordinary investors, said Witte, adding that the Securities and Exchange Commission is evaluating ways to give them access to private markets. While institutional investors such as pensions and endowments have long locked up their capital in private equity funds, average investors don’t have such access.
“There is a liquidity trade off,” he said. “That is why private capital has been limited — at least so far — to large sophisticated investors.”
Firms have experimented with structures that might allow private equity to make a breakthrough in 401(k) plans, where trillions of dollars are invested for retirement savings, according to Witte. In the meantime, many large and wealthy investors are planning to increase their allocations to private equity in hopes of finding returns that beat public markets.
About two-thirds of institutional investors have exposure to private equity, allocating an average 10 percent of their portfolios to the asset class, according to the EY report. A “modest shift” among existing investors could result in “significant additional inflows” to private equity, the report said.
Households, including family offices, wealthy individuals and ordinary investors, could really move the needle on inflows to private equity. Moving a mere one percent of their total equity holdings to private equity would translate into $149 billion of capital for the alternative investment industry, the report showed.
Private equity firms use different strategies, raising funds that invest in early-stage venture capital deals, growth capital strategies, and large leveraged buyouts. Companies can also turn to private equity firms as lenders, as seen in the growth of shadow banking over the past decade.
“We’re in the middle of this shift in the way that companies are getting funded,” Witte said. “Companies can spend more of their lifecycle on the private side.”
The boom in private equity is coinciding with stagnation in the public markets. The report described the growth as “one of the most profound shifts in the capital markets since the 19th century,” when public equity markets became widely accessible to investors and companies.
“It’s become increasingly clear that the model of public ownership is increasingly falling out of favor, at least for many companies in the middle-market space and those in the more growth-oriented stages of their maturity curves,” the report said.
While some businesses fare well under the scrutiny of a large shareholder base in public markets, others are better suited to private equity owners who can fund “transformational changes” beyond the public eye, Witte explained.
“It really boils down to who’s the best owner for a particular company or asset,” he said.
- Opportunities outside the US and Europe, where penetration is much lower: PE activity in the emerging markets has seen tremendous, albeit uneven, growth. According to data from the Emerging Markets Private Equity Association (EMPEA), activity in the emerging markets represented 23% of global PE investment activity in 2018, up from just 9% a decade ago. Powerful secular trends, including a growing middle class, an emerging consumer culture and strong demographics, make the emerging markets one of the industry’s clearest growth opportunities. In the US and UK, for example, average annual PE investment activity represents 1.7% and 2.1%, of GDP, respectively. In emerging markets such as India, China, Brazil, and sub-Saharan Africa, the penetration rate of PE is far lower – just 0.36% in India, and 0.16 in China, for example.
- Opportunities outside the equity stack: Some of private capital’s most significant growth may not come on from the equity side at all. Assets in the private credit space, including direct lending, distressed, and mezzanine funding have grown dramatically in recent years – from approximately US$240b a decade ago, to US$837b as of September 2018, according to Preqin. Investors appreciate the diversification benefits of the space as well as the opportunity to access returns (and risk profiles) that are generally higher than their other fixed-income portfolios. And while the industry is certainly subject to the economic and credit cycles, the longer-term trend is toward more activity shifting from traditional lenders to nonbank lenders. Recent years in particular have seen PE-backed credit funds underwrite larger deals that would once have been the exclusive province of the leveraged loan and high yield markets.
- Additional areas of growth: Many opportunities may come from companies that have traditionally been outside of PE’s purview. Longer-term funds, for example, are designed to hold companies for periods of 15 – 20 years or more, opening the investable universe to companies which may not be suitable for shorter hold periods.
For example, Permira, a global private equity firm, just announced it has closed its latest fund at 11 billion euros ($12.13 billion) of committed capital:
This latest buy-out fund, Permira’s seventh, will invest in businesses in the technology, consumer, financial services, healthcare and industrial technology industries. It has so far committed to two new investments.There are a few other brand name funds that announced similar large closings of multi-billion dollar funds.
Permira began raising cash for this fund at the start of 2019, and it said that existing investors as well as new ones had made commitments.
Earlier this year, the California Public Employees Retirement System disclosed it had committed 520 million euros to the fund.
Much has been written on the changing landscape of public and private equity investing but the reality is direct investing in private companies is only reserved for the most sophisticated institutions which have the ability to co-invest in private equity deals alongside their partners. The barriers to investing in private equity are too high.
This is yet another reason why I'm an ardent defender of expanding well-governed public defined-benefit plans to more citizens looking to retire in dignity and security.
Times are so good for private equity funds that according to William Cohan, private equity headhunters are bleeding Wall Street.
How long will the good times last? We shall see, valuations are stretched, there's record dry powder, the industry is preparing for the next downturn, but as long as investors are looking for yield, private equity will be in big demand.
While private equity is booming, however, Christine Idzelis of Institutional Investor reports that investors signal caution after hedge funds stumble:
Investors are wary of making new hedge fund allocations after managers stumbled into their first quarterly loss of the year.According to Bloomberg, even endowments and foundations cut their hedge fund exposure in the last year, citing high fees and concerns about liquidity and transparency:
The industry declined 0.21 percent during the three months through September, dragged down by losses in August, according to a Preqin report Thursday. The number of hedge funds created in the third quarter dropped about 45 percent from the previous three months, “perhaps as managers put plans on ice in a difficult macroeconomic climate,” the alternatives data provider said in the report.
The majority of investors seems to be taking a “cautious approach” to the asset class, with 73 percent expecting to allocate less than $50 million in fresh capital to hedge funds over the next year, according to Preqin. Sixty-one percent of investors said they wanted more diverse portfolios regionally, and were seeking global mandates to mitigate geopolitical risks and heightened market volatility.
“As recessionary fears grow, the hedge fund sector is facing challenges – and opportunities – on multiple fronts,” Preqin said. “Long/short equity remains the most sought-after core strategy.”
Fifty-one percent of hedge fund mandates are targeting long-short equity over the next 12 months, the data tracker said. Macro is the next most popular strategy in fund searches, followed by multi-strategy hedge funds.
Macro was the best-performing core hedge fund strategy in the year through September, with a 5.61 percent return, according to Preqin. That’s more than double the 2.14 percent gain produced by hedge funds across all strategies over the same period, according to the firm’s benchmark index.
“The proportion of macro strategies funds also rose significantly between quarters,” Preqin said of the number of funds launched during the third quarter. “Perhaps investors are increasingly looking for downside protection.”
Hedge funds focused on credit strategies had the second biggest returns in the year through September at 3.96 percent, followed by multi-strategy at 2.95 percent, the report shows. The same categories were top performers in the third quarter with gains of about 1 percent each.
Event-driven hedge funds, meanwhile, saw the worst performance in the third-quarter, tumbling 1.36 percent to increase their losses to 1.5 percent for the year through September.
Investors have faced “an increasingly turbulent political backdrop,” while central banking moves haven’t quelled fears of an economic contraction, according to Preqin.
Two rate cuts by the Federal Reserve during the third quarter failed to “ignite investors,” the firm said. “When the U.S. yield curve inverted in August, fears of an impending recession intensified.”
A survey released Thursday found that 37% of institutions polled reduced hedge fund wagers, while 14% increased them and about half remained unchanged. About a fifth said they plan to cut their exposure to the asset class in the coming year, according to the report by investment consultant NEPC.Earlier today, Zero Hedge posted some performance figures on hedge funds stating"Cohen, Griffin, Balyasny All Hammered By Quant Quake."
Endowment returns slumped in fiscal 2019, hurt by their exposure to international equities. Schools have also piled into hedge funds. The average fund was flat in the 12 months through June while the S&P 500 rose more than 10%.
Most of the endowments and foundations surveyed have a fifth or less of their portfolios committed to hedge fund managers. For those that made cuts, 20% was redeployed to fixed-income, while 17% went to private equity and credit, the poll found.
A quarter of those surveyed said the biggest challenge with hedge funds is high fees while 16% cite low or disappointing performance.
NEPC’s results are based on about 50 respondents covering the 12 months ended in September.
When you read the comment, however, it doesn't seem like last month's Quant Quake 2.0 was a real negative factor for most funds as pain was muted among hedge funds.
Still, there's an ongoing debate on whether hedge fund fees remain "painfully high" rewarding asset gatherers and not aligning interests with their investors.
This remains one of the biggest sticking points in Hedgefundistan and many investors are increasingly scrutinizing these fees in a low-rate, low-return world (it's a lot easier charging 2 & 20 when rates are high, almost impossible when they're flirting with negative territory).
Lastly, with the next US presidential election just a year away, institutional investors are growing worried about how the result will impact their portfolios, especially private equity funds.
I suspect if she gets elected, Elizabeth Warren will make everyone on Wall Street nervous, not just private equity.
Below, watch Securities and Exchange Commission Chairman Jay Clayton in conversation with CNBC anchor Andrew Ross Sorkin at the 2019 Delivering Alpha conference hosted by CNBC and Institutional Investor.
Also, TPG Capital Co-Managing Partner Todd Sisitsky sits down with Bloomberg Editor-at-Large Erik Schatzker for a wide-ranging discussion on how to invest in today’s environment at Private Capital in New York on October 3, 2019.
Third, Bruce Flatt, Brookfield Asset Management chief executive officer, discusses the outlook for private equity and Brexit with Bloomberg's Jason Kelly at the Bloomberg Global Business Forum 2019 in New York.
Lastly, early September saw a massive shift from long-favored momentum stocks to value equities. Bloomberg's Sonali Basak takes a look at how this momentum reversal impacted hedge funds. She speaks on "Bloomberg Markets: The Close."
It's important to note that momentum has come back nicely this month and barring another December disaster like last year, a lot of these September losses by big hedge funds will be made back.