Returns on leveraged buyout investments are falling, despite high levels of institutional capital chasing the asset class, new research shows.
According to a report on second-quarter leveraged buyouts from eFront, an alternative investment software firm, the quarter was the third in a row in which these funds experienced declining returns on investments.
Still, the declines came nowhere close to the level seen during the 2008 financial crisis, according to the report, which was published on Wednesday.
This is as alternative investment data provider Preqin reports that during the first three quarters of 2018, private capital funds raised $192 billion per quarter on average — a slight decline from record levels in 2017, but still high.
“Risks have inched higher, but from an all-time low, meaning that while fund manager selection is more challenging, the general trend is towards lower risk in private equity fund selection,” said Tarek Chouman, chief executive of eFront, in a statement. “Putting capital to work is, however, ever more difficult, as time-to-liquidity decreases sharply, reflecting the growing challenges presented by high levels of dry powder and increasing competition.”
The average return multiple created by active leveraged buyout funds during the second quarter in 2018 fell to 1.45 times, as compared to a peak of 1.49 in the third quarter of 2017, according to eFront’s report.
The report noted, however, that performance is still well above what was seen during the financial crisis, when returns fell below 1.1 times.
“2018 has seen a return to more normal LBO fund performance levels after a decade of steadily rising performance,” Chouman said in the statement.
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In other words, leveraged buyout fund performance may have hit its peak during the third quarter of 2017 and is now steadily normalizing.
Another signal that the leveraged buyout market is normalizing is an increase in dispersion between the top and bottom five percent of fund performance. That spread is hovering around 1.34, as compared with a low of 1.28 in the second quarter of 2017, according to eFront’s data.
Still, though, eFront’s data show that fund selection still matters, even with returns relatively high. According to the data, funds from vintage years 2011 and 2013 underperformed the average, while vintage year 2012 outperformed and 2014 is on track to outperform.
Funds based in the United States outperformed the average, while those in western Europe were more volatile, which eFront attributes to the instability of the euro.