There are a number of ways you might describe this past year for the private equity industry. 2015 was marked by massive fundraisings, record exits and distributions to LPs. The industry also faced significant challenges in terms of soaring asset prices, changing credit market conditions and public controversy over fees, taxes and transparency.
Moving into 2016, here are five key areas we expect to shape the asset class:
1. The mountain of dry powder will grow
Dry powder rose 23 percent to an eye-popping $1.3 trillion during the first three quarters of 2015, according to placement firm Triago. There are differing figures out there, but no denying the mountain of unspent private equity capital is substantial, with some of the industry’s largest alternatives managers having built up significant war chests – Blackstone, Apollo and Oaktree come to mind, which are sitting on $85 billion, $27.5 billion and $20 billion, respectively – and near-record fundraising levels showing no sign of abatement. How quickly that capital is deployed and on what remains to be seen. Should entry levels remain high, our sources say platforms, add-ons and corporate carve-outs are likely to take the lion’s share of investment as GPs avoid high-profile auctions and take-privates. But if rising interest rates depress public market valuations, as Carlyle’s David Rubenstein has suggested could happen, “prices are less expensive and it’s easier to buy things”.
2. The LP base and GP product mix will keep evolving
More than 87 percent of investors expect their allocation to the asset class to either remain the same or increase over the next two years, according to our latest LP Perspectives survey. But that doesn’t mean it’s all status quo. New institutions, notably Japanese pension funds, are eyeing the asset class for the first time, while some established investors like sovereign wealth funds, Canadian pensions and family offices have been sharpening their focus on direct investments. Meanwhile, LPs with mature portfolios are also reducing the number of relationships on their books and investing larger sums with preferred GPs. Alternatives managers are expected to increasingly offer co-investments, separate accounts and hybrid fund structures that blur the lines between asset classes for their largest LPs, while also developing products that appeal to retail investors and respond to a shift by one of the industry’s prime funding sources – US public pensions – towards defined contribution benefit models.
3. Fund terms won’t be one-size-fits-all
Record cashflows back to investors in the last two years have made for a fantastic fundraising environment as LPs seek to put that capital back to work. With the ball remaining in top-performing GPs’ court, expect many more funds, large and small, to follow the lead of industry giants such as Bain Capital, EQT and Advent International in introducing new twists to standard Ts&Cs. Hurdle rates, key-person and no-fault divorce clauses, waterfall arrangements, fees, fund life and investment period lengths are among the terms where market sources expect to see continued variation and experimentation.
4. Fees will remain in the spotlight
As the California Public Employees Retirement System would tell you, private equity fees have been a hot topic in 2015 and we don’t see that changing anytime soon. As transparency and reporting standards evolve, the SEC steps up its enforcement action on fee-related issues, and the US presidential election stirs debate around carry tax, the public (and mainstream media) will increasingly be exposed to private equity-related stats and information that, as CalPERS’ recent experience demonstrates, can easily be misunderstood or misconstrued. Regulators, the media and the private equity industry itself are also likely to delve deeper into issues that haven’t yet hit headlines, such as fees on committed versus invested capital. And, as sister publication pfm noted recently, expect some related PR battles ahead.
5. Funds of funds will have a revival
Industry insiders have been tolling the bell for funds of funds for years, but these managers have a vital role to play in the market, and never more so than today. Funds of funds are uniquely placed to help large LPs resolve the dichotomy between manager consolidation and the need to write ever larger cheques, and their desire to take advantage of smaller and more niche managers. They’re also a trusty guide for virgin investors and those exploring emerging and frontier markets for the first time. And, many sources say, funds of funds are arguably best placed to respond to those aforementioned shifts in pension models. Yes, many have and will fall by the wayside, but those that have successfully adapted their models and fees will continue to flourish and offer investors a meaningful alternative.
One thing is certain: the industry is maturing, overcoming challenges and changes only to face new ones. What do private equity insiders make of the year ahead? We’ll share their thoughts and predictions in our ‘Outlook 2016’ series, which will be published on our website throughout the holiday break.
As this is our last ‘Friday Letter’ of the year, with our newsroom winding down on the 24th, we’ll sign off with best wishes for the year ahead.