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Earlier this week, MainFT reported that hedge funds are complaining that their fundraising efforts are being hurt by the amount of money investors have locked up in private equity funds — which are not making any returns.
As Michael Monforth, Global Head of Capital Advisory at JPMorgan Chase told our colleagues:
Lower distribution rate from private capital, [private] of debt and hedge funds has a backfire effect, leading some allocators to stop new investments in illiquid funds and reduce new investments in more liquid hedge funds.
That’s why FT Alphaville was curious, though: how big is the gap between the money private equity firms have claimed and the returns they’ve actually recycled back to investors? So we asked Preqin for the data, and friends, it’s absolutely massive.
Private equity firms took more money from investors than they returned in profit six consecutive yearsfor a total gap of 1.56 trillion dollars during that period.
And this is not only about the recent saturation of capital raised, delayed returns and blockages of the exit of private capital. Even if you include the big returns in 2013-2017, private equity funds have now requested $821 billion more than they returned over the 14 years spanning Preqin’s data series.
You might think that in a ruthless, meritocratic industry like private equity, this might have affected compensation? Ahahaha no, of course not you sweet child.
FTAV looked at the labor and equity costs of North America’s largest publicly traded private equity firm, totaling more than $100 billion over the past five years.
There’s a reason Oxford finance professor Ludovic Phalippou called the industry a “billionaire factory” in a landmark 2020 paper examining private equity returns.
U.S. PE funds raised $1.7 trillion between 2006 and 2015, generated $230 billion in carried interest and delivered to investors an overall net performance equal to that of stock indexes and small-cap mutual funds). Most of that money goes to the largest PE firms, and within the largest PE firms, most of the money goes to a few partners, often the founders. At least that was the model until a few years ago. First, the four largest PE firms went public in the late 2000s. From then on, the Carry they earn (as well as other fees) is distributed to their shareholders (including the founders). Next, over the past few years, some PE funds have bought stakes in private PE firms and thereby paid existing shareholders (mostly the founders of those firms) a large sum of money to gain access to a stake in their future flow of fees and Carry. These transactions have made many PE firm founders multi-billionaires. Many founders who have not sold part of their PE firms are also likely multi-billionaires, but have not realized that value and therefore do not appear in the multi-billionaire rankings.
Of course, these things move in cycles. Of course, there are years in which more money will be collected than returned. And maybe the trillions raised over the past 4-5 years will end up returning many times over to investors over the next decade.
But the fact that private equity alone sits at a record 28,000 companies worth an estimated $3 trillion at a time when most stock markets are at or near record highs does not inspire confidence. There’s a reason why shares in PE and VC funds are sold at often steep discounts.
There appears to be a huge mismatch between what private equity and venture capital have paid for many assets, the returns their investors expect, and what the public markets or other potential buyers are willing to pay.
And as long as that’s true, there will be a long and hard case of investor indigestion to deal with. However, NAV loans can only take you so far.
Further reading:
— Is private capital really worth it? (FTAV)
— Revisiting private equity valuations (FTAV)
— The ‘dry powder’ of the private equity industry has reached $4 billion (FTAV)