Private Equity Fundraising Grows but Can It Continue?

After a dip in 2008, private equity fundraising has begun to revive. Can it continue to deliver competitive returns?


After shrinking badly during the financial crisis, the private equity industry is beginning to revive. According to Preqin, fundraising totaled $77.3 billion in the second quarter this year, up from a low of $55.7 billion in the third quarter of 2011. The peak figure came in the second quarter of 2007 when private equity funds raised $212.9 billion. Total assets at the end of 2011 were a record $3 trillion, up 9 percent from the year before.

Of funds that closed during the first six months of this year, managers spent 16.7 months raising assets. That was down from 18.5 months in 2011. Funds that closed in the second quarter include AXA Secondary Fund V, a Europe-focused fund that raised $7.1 billion, and Green Equity Partners VI, a $6.3 billion buyout fund.

Preqin says that fundraising should increase in the next year because some big funds are likely to close and many investors seem eager to invest. Warburg Pincus Private Equity XI aims to raise $12 billion. According to a survey by Preqin, 73 percent of private equity investors plan to make new commitments this year.

In recent years, many institutions have been increasing their allocation to private equity. According to the Wilshire Trust Universe Comparison Service, institutions with more than $1 billion in assets have 9.1 percent of assets in private equity. That is up from 4.0 percent in 2006. Preqin says that endowments have been especially big investors, holding 13.2 percent of their assets in private equity this year, up from 8.4 percent in 2007. Foundations currently have a 10.7 percent allocation.

Solid returns have been attracting investors. “Private equity can deliver the kind of high returns that pensions need to meet their obligations,” says Jim Neill, managing director of Wilshire Associates.

During the 10 years ending in December 2011, private equity returned 11.9 percent annually, compared to 2.9 percent for the S&P 500, according to Preqin. Some kinds of private equity did considerably better than average, including distressed and buyout funds. Many funds suffered big declines in 2008, but the industry has rebounded sharply. During the three years ending in 2011, funds returned 13.9 percent annually. “The introduction of mark-to-market valuations led to steep losses in 2008, but since then, private equity has been in a state of recovery,” says Alex Jones, a Preqin analyst.


Can private equity continue delivering competitive returns? Some analysts argue that returns are likely to be stifled in the future because of more difficult financing conditions. During the boom years before the financial crisis, private equity funds used leverage to boost returns. These days financing is tight, and funds are forced to put more equity into deals. That could hurt results. “Returns are likely to come down a little bit,” says Neill.

Whether or not financing becomes available, private equity can continue outdoing the public markets, says Peter Von Lehe, a managing director of Neuberger Berman. He says that private companies typically trade at lower multiples than comparable public companies command. (Publicly traded companies may cost more because of their liquidity advantages.) When they go to sell, private equity funds can obtain prices for their holdings that match the levels of public markets. As a result, private equity produces fatter profits.

Von Lehe says that the shortage of financing is not all bad news. Because of the lack of leverage, prices of private deals have come down in recent years. That creates opportunities for managers to boost profits, says Von Lehe. In addition, portfolio companies are less risky because they are saddled with little debt. And with financing tight, there is not an excess of capital chasing deals and eroding profits. All that could enable private equity to remain an appealing asset for investors with long time horizons.