We recently received a Private Equity factsheet from Preqin. Founded in 2003 Preqin has become a trusted source of information about alternative asset strategies like private equity, venture capital, real estate, hedge funds and mezzanine funds. Many alternative asset managers share their performance statistics with Preqin and we are always interested in the trends they are observing. Preqin’s Private Equity Online features extensive information on the buyout industry, including over 3,800 funds, 3,100 fund managers, 49,000 deals, 21,100 exits and much more.
Their latest factsheet shows an interesting scorecard for alternative assets compared to the S&P500. For the period January 1, 2001 to December 31, 2014 only Preqin’s Venture Capital Index underperformed the S&P500 and Fund of Funds appear to be highly correlated to that public index. Buy outs, Distressed Private Equity and Real Estate dramatically outperformed the S&P over that 14 year period.
Escalating Exit Values Drive Investment Returns
Starting in 2010 there is remarkable consistency in the average number of global buy out deals (1000) but the value of those deals has risen from $50 billion to almost $140 billion in 2014. Preqin does not report the median exit values so the 2014 results may be skewed by large PE backed acquisitions. For example in 2015 PE backed Dell’s purchase of EMC alone was $67Billion.
Fundraising was quite active and dry powder reported by the top 10 US and UK buyout firms exceeded $120 Billion. That equates to almost $750 Billion of buying power overhanging the M&A marketplace just from the 10 biggest players. With all of this capital chasing a pretty static number of available properties it is not surprising that the deal values are going up and reported returns are sliding. The 1 year returns (horizon IRR) for the period June 2014-June 2015 for Buyout Strategies has fallen to a little more than 16% versus ten year horizon returns that are slightly greater than 18%. During the ten year period venture capital has a superior one year horizon IRR of more than 20% whereas over the longer ten year horizon the VC returns have barely exceeded 5%. The message for anyone who is paying attention—now is the time to be a seller even in an embattled asset class like venture capital.
The exit statistics confirm the sellers’ market. In 2009 there were about 700 exits with an average exit value of approximately $175 billion of which slightly more than 200 were either restructurings or IPOs. In 2014 (a peak) there were almost 1800 exits with an average exit value of $450 billion. Only 380 of those exits were IPOs or restructurings. The trend line for exits through the public markets is falling just like the statistics for initial public offerings of all varieties. The M&A market is the preferred liquidity path for private equity sponsors.
Smart Money Is Clamoring For Private Equity
The Preqin report also confirms most of the trends we are seeing. The unwritten story may be that investment returns from later vintage funds (2014 and 2015) may dramatically undershoot the most recent horizon returns of slightly more than 16% simply because entrance prices keep going up and the exit prices appear to have peaked. Meanwhile unit growth is challenged in almost all corners of GDP. Even interest rates are threatening to break out of the basement and an indebted America portends increasing taxes. The PE business model has benefitted from all of these variables playing in almost perfect harmony over the last 10 years.
Despite the headwinds and cautions, private equity is the place all the smart money is going. Maybe it is because it is the only asset class where there is any chance of long terms returns above 10%. That actuarial result is imperative for underfunded pension funds who have constructed benefit assumptions around historical returns of 6-8%. One of the risks for the PE asset class, especially larger pools, is inability to put money to work at attractive returns. Success in fundraising may be perverse. However, niche strategies and focus on inefficient pockets like the lower middle market may still provide IRRs in excess of 20%. A larger challenge is the taxation of carried interests. Both of the presumptive candidates would end the favorable capital gains treatment in which case you may see early retirements and other leadership defections in this great asset class.
In the meantime if you have been prescient and have invested in the private equity class, take a moment to savor a job well done.
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