The Private Equity Paradox

Small funds tend to deliver the best returns — but mega funds keep raking in capital.

Henry Kravis, co-founder of KKR & Co. (Justin Chin/Bloomberg)

Henry Kravis, co-founder of KKR & Co.

(Justin Chin/Bloomberg)

Institutional investors continue to commit billions to massive private equity funds, despite slowing deal flow and increasingly high levels of dry powder.

Five private equity firms announced in as many days that they had raised an aggregate of roughly $42.2 billion to put to work in private equity. This is despite data from groups like alternative asset manager Pantheon and data provider eFront that shows that smaller firms and smaller buyout deals tend to deliver better returns for investors.

“There is an inherent tension in institutional investing,” Michael Rosen, chief investment officer at Angeles Investment Advisors, said via email Tuesday. “A critical mass of assets is necessary to attract and maintain sufficient resources to be able to identify superior investment ideas. But exceptional investments are both scarce and capacity-constrained.”

Public pension funds are some of the major institutions deploying their capital into these mega-funds, meeting minutes show. And they have options: nearly 4,000 funds are in the market, targeting fundraises of nearly $1 trillion, according to a July report from Preqin.

“A small investment is hardly worth their effort, even if it is a great investment, as it just won’t be big enough to have an impact on the larger portfolio,” Rosen said.


Private equity mainstay KKR & Co. announced Tuesday that it had closed its largest-ever European fund with €5.8 billion ($6.4 billion), which it will primarily deploy in Western Europe. Investors included the Minnesota State Board of Investments, the California Public Employees’ Retirement System, and New York City Employees’ Retirement System, among others, meeting minutes show.

Also on Tuesday, a new private debt firm called Arcmont Asset Management, backed by Neuberger Berman’s Dyal Capital, announced that it had launched with €13 billion in assets under management.

“People will invest in these very big funds because they’re easy to invest in,” David Lanchner, a spokesperson for private equity placement agent Triago, said by phone Tuesday. “Due diligence is easy, and you can invest a lot of money at once.”

This way, Lanchner said, investors can spend more time researching the smaller, more niche strategies. “They get beta from the big funds and outperformance or alpha from the smaller funds,” he added.

Still, KKR and Arcmont weren’t the only funds to announce that they are raking in the dough this week.

[II Deep Dive: Has Private Equity Lost Its Original Purpose?]

Brookfield Asset Management said Monday that it had closed its fifth private equity fund with $9 billion to deploy, exceeding its original $7 billion target. Investors included the South Carolina Retirement Investment Commission and the New Jersey State Investment Council, meeting minutes show.

On the same day, Altas Partners closed its second fund with $3 billion to deploy. Investors included Louisiana State Employees Retirement System and a few local county retirement systems, according to meeting minutes.

In addition, a November 1 Securities and Exchange Commission filing from Platinum Equity Capital Partners shows that it has raised nearly $9.4 billion for its fifth fund. Investors include the Kansas Public Employees Retirement System and the New Mexico State Investment Council.

There can be attractive reasons to invest in mega-funds, according to Lanchner. He noted that they have a small number of competitors when it comes to deals. “They would argue that they’re investing on a scale that other firms can’t invest on,” Lanchner said.

And it’s not like these mega funds are just throwing money at any available deal. In fact, an August report from EY showed that the number of deals completed by private equity firms in the second quarter declined by 11 percent year-over-year.

Still, Rosen believes that the main function of these mega-funds is to help huge investors deploy their capital.

“The mega-funds exist not to deliver exceptional performance, but to provide capacity for massive pools of capital seeking a home,” Rosen said. “If history is a guide, and it is, most of these mega-funds will produce mediocre returns, which will (just) satisfy their investor base, and generate massive fees for the GP. Win-win?”

A previous version of the story said that Arcmont had announced that it had raised €13 billion. This is not the case. The firm spun out of another, and now manages €13 billion. II regrets the error.