Private Equity Fund-Raising Has Been Good—Maybe Too Good?

Private Equity Fund-Raising Has Been Good—Maybe Too Good?

While the enthusiasm for private equity is clearly a positive, it raises the heat considerably on both investors and funds to work harder and smarter.

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Private Equity Fund-Raising Has Been Good—Maybe Too Good?

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If the recent past has taught us anything about private equity, it’s that the asset class has enormous appeal among investors. Over the last five years, funds globally have raised more than $3 trillion in capital, including $701 billion in 2017. Buyout funds have led the pack in fund-raising, but the persistent flow of investment has benefited almost every PE sub-asset class and geographic region.

Annual fund-raising data can be lumpy because it only counts capital once a fund closes, no matter how long it’s been on the road. But as discussed in Bain & Company’s Global Private Equity Report 2018, there’s no denying the strength of the five-year trend. PE funds have attracted significantly more capital since 2013 than during any other five-year period in history—including the frothy five years preceding the global financial crisis.

While some investors are starting to question whether the extended surge in capital is a sign that the PE markets are getting too hot, surveys indicate that limited partners (LPs) remain committed to the asset class. The most recent survey by Preqin, which provides data on alternative assets, shows that 92% of LPs plan to devote the same amount of capital or more to private equity in the coming 12 months, and 96% say they plan to maintain or increase their PE allocations over the longer term. Private equity’s superior payback helps explain why. As of midyear 2017, the median net return of PE holdings in the portfolios of public pension funds over a 10-year time horizon was 8.5%, compared with 4.2% for public equities, 4.5% for real estate invest­ments and 5.2% for fixed income.

The number of funds on the road and the size of their capital targets continued to climb in 2017. The aggregate level of capital sought by PE funds was $1.9 trillion, or 19% more than in 2016, and the amount sought by buyout funds alone was $452 billion, or 8% higher than the year before.

Overall, more than two-thirds of PE funds that closed in 2017 met or exceeded their target amounts, and 39% took less than a year to close. Among buyout funds, the success rate was even higher: 85% met or exceeded their targets, and a full 68% closed in less than a year.

Amid the general enthusiasm, it’s clear that investors are skewing toward large, established players, allowing top PE firms to raise ever-larger funds. Indeed, 2017 produced a number of new records. The $24.7 billion Apollo Investment Fund IX was the largest single buyout fund raised in history. The $18 billion (€16 billion) CVC Capital Partners Fund VII was the largest euro-denominated fund ever raised. KKR’s $9.3 billion Asian Fund III was the largest-ever Asia-focused buyout fund, which is especially notable since the region has not been a buyout market historically. Overall, megabuyout funds—those with more than $5 billion in assets—raised $174 billion in capital in 2017, or 58% of the year’s buyout total. Those numbers represent a steep increase from the $90 billion and 38% logged in 2016.

As one measure of the extraordinary investor enthusiasm in 2017, all 10 of the largest funds closed during the year raised more than their targets, and they easily could have raised even greater amounts. Consider that CVC initially set an ambitious target of $14.5 billion for its Fund VII, but demand was more than double that, surging past $30 billion. CVC eventually capped the fund at $18 billion, or 126% of its original target.

There’s little doubt that general partners (GPs) view this period of heated investor enthusiasm as a strike-while-the-iron’s-hot opportunity. At a time when LPs are having trouble securing allocations with established funds, they are giving first-time funds a big boost. In 2017, 319 first-time PE funds closed globally, including 9 funds of $1 billion or more. Established sponsors are also racing to launch new funds well before their predecessor funds have matured. A look at the 20 largest buyout firms globally shows that the gap between closing one fund and starting another has com­pressed to 40 months, from 62 months five years ago. For LPs, jumping in earlier requires a leap of faith, since there’s no real way of know­ing how well a fund is doing just three years after the close.

Such enthusiasm for private equity is clearly a positive for the industry. But it also raises the heat considerably on both investors and PE funds to work harder and smarter. For LPs, capturing the outperformance of private equity is predicated on the investor’s ability to separate the best from the rest. Inevitably, that becomes harder as capital floods into the asset class and LPs compete fiercely to put their money to work with a limited number of top-performing funds. For GPs, the challenge is putting that flood of capital to work productively amid record-high asset prices, extreme competition from corporate buyers and a hazy macroeconomic outlook. The industry is riding on a promise of continued momentum. Now comes the hard part.

Hugh MacArthur, Graham Elton, Daniel Haas and Suvir Varma are leaders of Bain & Company’s Private Equity practice.