Private equity fund managers are being disciplined about making deals in the current heady investment climate — which is good news for investors but a mixed bag for private equity firms, because they don’t earn fees on uncalled capital and can’t find attractive opportunities in which to invest, a new report says.
Distributions from global private equity funds have significantly outweighed capital calls over the past five years, according to a report released today from eFront, an alternative investments technology firm. The trend of distributions exceeding capital calls was the most pronounced in 2017, according to eFront’s report on capital call and distribution activity that was based on the analysis of 4,000 global funds.
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“If I put myself in the shoes of an institutional investor, I would probably feel relieved that the firms I’ve invested in are not going crazy spending this money in an uncontrolled manner,” said Thibaut de Laval, chief strategy officer of eFront, in an interview. “But then I would be concerned that this cash is not being put to work and that I’m going to be disappointed in three to four years.”
In the fourth quarter of 2017, the most recent data available, firms called 1.19 percent of total capital committed, while distributions were 3.47 percent of the funds — a level last matched in the fourth quarter of 2013.
Capital calls are at record lows. During 2017, capital calls were an average of 1.1 percent of total commitments. In 2016, calls were an average of 1.37 percent.
The tech firm reports that institutional investors, with hefty distributions in hand, may commit even more capital to private equity through the end of 2018.
Investors want their private equity managers to be cautious about their deal-making during a bull market. The more firms pay for portfolio companies, the lower returns will be for investors down the road.
But the record amounts of dry powder — money committed but not yet put to work — that is building up in the industry may force private equity managers to extend their investment periods. As well, firms don’t collect fees on money they have not yet received from investors.
“In the next 12 months to three years, there will be a moment of truth for private equity,” says de Laval. “Now that they’ve had record fundraising, can they really put this money to work?”
The report's authors wrote that the pace of capital deployment is “even slower than during the worst of the 2007-2009 crisis,” which they cited as "clear evidence of discipline in capital deployment by fund managers, and of a build-up of dry powder.” Since 2014, capital calls have been below the historical low hit in 2009.
As a result of the record distributions, private equity funds are actually shrinking, a fact masked by assets under management. Assets in private equity funds are the sum of dry powder and the value of the portfolio. The portfolios’ assets under management have climbed based on current lofty valuations that have overshadowed the huge volume of distributions made to shareholders as firms exit their investments, according to eFront.
The overall health of markets is directly correlated with distributions. In examining the market drop in the first quarter of 2016, eFront found that distributions dipped from 3 percent in the fourth quarter of 2015 to a little more than 1.74 percent in Q1.