Hamilton Lane Flashes Warning on Buyout Funds

Fundraising has been strong, but the private markets firm reports that it appears to have peaked.

Illustration by II

Illustration by II

Investors are getting a warning when it comes to buyout funds.

Evaluating indicators such as purchase price and leverage multiples, coverage ratios — the ability for a company to pay debt — and other measures, investment firm Hamilton Lane said it’s concerned that the environment for buyout funds is getting somewhat overheated.

“For the buyout market, you can see the picture is becoming less attractive,” the firm said in its 2019-2020 market overview, released Thursday.

The firm, however, noted that general partners are showing “some real self-restraint.” Hamilton Lane says GPs of buyout funds are being disciplined when it comes to spending on new deals, given the total amount of dry powder, or cash, they have on hand.

In contrast to buyout funds, the private market firm’s so-called sentiment indicator is neutral on both credit and real estate funds.

Although the firm has an optimistic perspective on a number of trends in private markets, it believes the environment is frothy.

“Things are clearly getting overheated, and we think we are much closer to a top than not,” according to the report.

[II Deep Dive: Is the Illiquidity Premium a Myth?]

“We’re trending negative, but we’re not where we were in 2007,” the last peak for private markets, said Drew Schardt, head of credit at Hamilton Lane, at a press breakfast to discuss the annual study.

The firm, a manager and allocator of private market capital, used proprietary data on $5.3 trillion in fund commitments, 19,000 deals, and 43 vintage years to produce the annual market overview.

While investors have been throwing cash at private equity funds for years, Hamilton Lane argued that the fund raising trend looks like it may have hit the top.

Fundraising for global private markets, which is strong, has still been tailing off the past two years, according to the report. In 2017, fundraising was about $900 million, dropping closer to $800 million in 2018. If activity continues at the same pace as it has so far in 2019, firms will raise an amount this year that’s close to the level garnered in 2018.

The firm is concerned about purchase prices and leverage multiples, which are at all-time highs. The median purchase price multiple when private equity firms acquired companies was 11.7 times earnings in 2019, according to Hamilton Lane. The firm considers prices to be high when they are over 8.7 times earnings.

That said, Hamilton Lane pointed out that prices and leverage levels don’t tie to investment results. “If buying cheap is the recipe for success, then we should see the best results for the low priced deals, but we don’t,” according to the report.

Hamilton Lane said in its report that many investors hold negative opinions about private markets, in part because of enormous fund raising that has taken place and the amount of dry powder that still needs to be invested. Indeed, the absolute size of private markets has been growing much faster than public markets, with the number of private companies growing by 52 percent from 2012 to 2017, compared with 8 percent growth in the number of public companies over the same period, according to the study.

But that needs to be put in context, according to the firm. Despite the flood of capital coming in, Hamilton Lane reported that it’s only about 2 percent of the market capitalization of the MSCI World index.