Private equity has changed in the ten years since the financial crisis.
There has been a growth of scale. The big have become much bigger. Blackstone, for example, is some 20 times larger than it was in 2005.
This follows the trend elsewhere in asset management: the big become vast; the small operate as boutiques; the medium are neither one thing nor the other.
Blackstone, Apollo, CVC, Carlyle and a few others now account for roughly 50% of assets; the other 50% is spread between hundreds of other firms.
The medium firms have either done well or gone out of business. But even the good ones are heading for a much tougher time. Many will struggle to keep up when the cycle turns.
Investors are similarly more discerning. Pension funds and others are moving assets to the big players and cutting out small to medium ones. The mega funds are choosier, too, in whom they will accept. The business is maturing and with it comes lower returns for less risk.
It is also true that firms are not just private equity anymore; there is other stuff too – particularly credit, real estate and energy. Private equity titans have launched long-term funds – something they never used to do. They talk of great businesses that they want to own for a long time, and accept that this will mean a lower rate of risk and return. Again, this is quite different from traditional private equity. Blackstone’s recent stake in the former Reuters financial business for some £20bn is a case in point. There seems to be no intention of selling this any time soon.
Equity markets are shrinking. The buyback market in the US over the past ten years has been greater, at US$5tn, than the amount of quantitative easing by the Federal Reserve. In addition, there is a shortage of initial public offerings. Market capitalisation measures show the markets are rising, but this is from fewer and fewer companies. So private equity players have found it progressively more difficult to find companies to buy out.
Tencent, Alibaba and other Chinese players are buying stakes in promising technology companies, not just in China, but wherever they are allowed to go. This again makes it more difficult for private equity players to get a look in.
Metrics are stretched. Markets are high – private equity should be getting out. Instead, they have large funds that they cannot deploy. They have the firepower, but not the fire. Globally, half the deals have a multiple of 11 times EBITDA, which is as much as in 2007. Covenant light loans are commonplace. Leverage is back with a vengeance. It has the makings of a meltdown.
Finally, the sector still suffers from academics and others who do not believe the returns are worth the fees. And private equity still finds it too hard to say what those are.
The issue here is less one of shortage of funds because of Brexit, so much as shortage because of a bear market.
Of course, it is not there yet, but two quotes seem apposite.
Upton Sinclair, the American writer, 100 years ago said that it was difficult to get a man to understand something when his salary depended on not understanding it.
The psychologist Daniel Kahneman says, when something goes wrong, people first of all don’t know what to do and run around like headless chickens. But they then quickly embrace the change, saying it was always going to happen, so they are not surprised. Hindsight is a wonderful thing because in effect it means they did not see what was going to happen, but they think they did.
The hindsight problem
The 2008 crash was like this. People did not see it coming, but then they accepted it and that it was inevitable. And this makes executives far more bullish than they should be, because they rationalise the future as being a continuation of the past, rather than what it should be, which is an area fraught with uncertainty.
So, this is a sector that is in good health. But the trouble is that private equity people see what they want to see. They see markets that are very fully valued, but they don’t see that as a reason for not investing.
It is not just private equity; it is almost everyone in markets. But private equity has to live with the downturns much more. Like everyone else, I don’t know when this will be, but I do believe it will be a much smaller private equity sector that comes through it.
The original version of this article appears in the Q4 2018 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.
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