Private Equity Bubble? What Private Equity Bubble?
Record demand for private equity is prompting industry executives to take unusual action—selling all or part of their firms.
Some of the world’s largest publicly traded fund managers are snapping them up.
Private-equity firms are using money from the stake sales to hire more staff, create new kinds of funds and settle the often thorny question of how to buy out retiring founders.
Such sales are sometimes interpreted as signals the private-equity market is peaking. Why would such savvy deal-makers sell at any time other than the top, the thinking goes. Blackstone Group LP, the world’s largest private-equity firm, sold shares to the public as the stock market peaked in 2007. The shares subsequently slumped, taking six years to bounce back.
The rise in stake sales comes as private-equity firms are paying higher prices than ever for companies and raising record-breaking funds. Private-equity firms delivered double-digit returns in 12 of the past 14 years and only lost money once in that time, according to Preqin Ltd. data.
This makes them attractive targets for asset managers seeking more profitable alternatives to offering cheap and popular passive investments such as exchange-traded funds.
BlackRock Inc., Neuberger Berman Group, Schroders PLC and Aberdeen Standard Investments are all buying. Private-equity funds charge an annual fee of 1.5% and keep 20% of the profits from asset sales. An ETF typically charges a 0.26% fee.
“Is it a bubble? My answer is no,” said Alan Cauberghs, head of private assets at Schroders, one of the U.K.’s biggest fund managers, which bought Zurich-based private-equity investment firm Adveq Management earlier this year. “Private equity gives us the opportunity to create longstanding relationships with clients as opposed to clients who buy an ETF today and sell it back tomorrow.”
Traditional fund managers debated how to respond to the popularity of passive investments at a conference in London on Sept. 5. Jupiter Fund Management PLC Vice Chairman Edward Bonham Carter cautioned that private equity is becoming “a crowded space,” though he acknowledged its appeal.
“It is a high fee model,” he said. “Managers can make four, five, six times the amount they can make as a more conventional active fund manager.”
A bubble in private equity isn’t inevitable because firms have plenty of room to grow, according to Jim Strang, an executive at Hamilton Lane , a major investor in private equity. “Private equity, despite how much it has grown, is still tiny,” he said. “If you think about the scale of the industry in the context of the global public investment market it’s a very small part.”
Private-equity assets have more than doubled in the last decade to $1.75 trillion at the end of 2016. But that is still equivalent to less than 3% of the $71.5 trillion of publicly traded shares.
The proceeds of Adveq’s sale to Schroders went to its founders. Other private-equity firms have sold stakes to raise money to hire staff to create funds in new asset classes, ranging from private debt to infrastructure and real estate.
Creating new funds enables private-equity firms to put more money to work, said Michael Rees, who co-founded Dyal Capital Partners in 2011 specifically to buy shares in private-equity firms and hedge funds. Dyal, a unit of New York-based Neuberger Berman, raised $5.3 billion for its third fund earlier this year.
“Investors want more private equity, so private-equity firms want to offer bigger funds and different strategies,” Mr. Rees said in an interview. “To do that, they need more capital and so they come to firms like us.”
Dyal has snapped up stakes in top-performing private-equity firms Vista Equity Partners and Silver Lake as well as buyout giant TPG Capital’s special situations arm, TPG Sixth Street, in the last 18 months.
Aberdeen Standard is raising $1 billion for its first fund to buy stakes in private-equity firms. Credit Suisse Group AG is raising a new fund to buy stakes, as is Petershill, a unit of Goldman Sachs Group Inc.
“Many firms seek to launch new products and strategies,” said Aberdeen Standard executive Ajay Chitkara. “Strategic capital can help managers achieve these objectives.”
Mark McCombe, who oversees private equity at BlackRock, the world’s biggest asset manager, told a conference in London earlier this year the investible “universe is increasing significantly” as more investors expand into private assets including infrastructure. In June, BlackRock completed its acquisition of First Reserve Energy Infrastructure Funds.
In addition to asset managers buying into private-equity firms, some sovereign-wealth funds and family offices are muscling into the industry with teams capable of doing their own private-equity deals.
“If you think about why investors continue to be attracted to the asset class, it is fundamentally down to one thing, the performance,” Mr. Strang said.
As investors scramble to gain access to the asset class, the best performing firms are taking advantage by significantly increasing fund sizes and, in some cases, not setting a limit—known as a hard cap—on the amounts they can raise.
Apollo Capital Management LP this year raised $24.6 billion for the world’s biggest buyout fund. CVC Capital Partners raised €16 billion ($19 billion) for Europe’s biggest buyout fund.
The sheer scale of funds available to private-equity firms is unsettling some investors, who see parallels to the heady fundraising period before the 2008 financial crisis. Private-equity firms raised a record $233 billion in the first half of 2017, according to Preqin.
Prices for U.S. and European leveraged buyouts were at or near record highs above 10 times earnings in the first half of 2017, according to Fitch Ratings. Soaring asset prices are a concern. A recent survey found that 86% of investors identified pricing as their main worry for the industry in 2017, according to Preqin.
“It is feeling very, very frothy,” Rhonda Ryan, a managing director at investment adviser Pavilion Alternatives Group, said in an interview.
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