The biggest listed US private capital companies have more than tripled in value since the depths of last year’s market sell-off, as investors seek to benefit from the hefty fees they rake in from the boom in unlisted assets.
The combined market value of Blackstone, KKR, Carlyle, Apollo and Ares has ballooned from a March 2020 low of $80bn to about $252bn this year, and private equity chiefs sounded an ebullient tone on earnings calls with analysts this summer.
“We are fortunate to be in a growth business,” said Marc Rowan, chief executive of Apollo Global Management. “Almost every day, the business gets better. The trends in the business are overwhelmingly favourable.”
Stephen Schwarzman, Blackstone’s chief executive, called the firm’s second quarter “the most consequential in our history”, both in terms of its financial results, but also for the wider trajectory the alternative asset manager was now enjoying. “Our forward momentum has never been stronger,” he told analysts.
Part of the attraction of buying shares in private capital groups is exposure to the high management fees that institutions such as pension plans or insurers are willing to pay for their funds.
These big investors are confronting a tricky market landscape. Although the market rebound since the depths of the coronavirus crisis has lifted the value of assets they hold, the outlook for further gains now looks limited in almost all leading bond and equity markets, given record or near-record valuations.
As a result, many are turning to private equity, venture capital, infrastructure, real estate and direct lending — strategies often grouped together as “private capital”, as they invest in opaque assets that do not trade on public exchange — to amplify their returns.
“People are quite worried about the long term prospects of listed equities and fixed income, and therefore need to look at alternatives to generate their target returns,” said Garvan McCarthy, a partner at investment consultancy Mercer.
Money is being raised faster than it can be invested. Fundraising has been so strong that the five listed US alternative investment firms alone have “dry powder” — money committed by investors but not yet deployed — of about $440bn, according to Goldman Sachs. That is the highest on record, and twice their firepower four years ago.
Their combined assets under management, in everything from classic leveraged buyout funds to late-stage venture capital and private debt vehicles, stood at $2.1tn at the end of June, up almost 37 per cent compared with June last year.
“We continue to benefit from the strong secular tailwinds driving the demand for alternative private assets and investor thirst for durable yield,” Michael Arougheti, Ares Management’s chief executive, said on the company’s recent earnings call.
The entire private capital industry manages $7.4tn and this will grow to $13tn by 2025, Morgan Stanley forecasts. “The velocity of virtually all aspects of our business has increased,” Kewsong Lee, Carlyle’s chief executive, told analysts on a conference call earlier this summer.
“Deals are being completed on shorter timelines, financings are being executed more quickly, opportunities for exits are presenting themselves sooner, funds are being raised faster than ever before, and accelerating impact from disruptive technology and changes from the pandemic are powering an increased demand for private capital across sectors and regions,” he added.
Nonetheless, the top-performing private capital funds can only accept so much of institutions’ cash and are typically oversubscribed. This is causing money to flow to players and strategies that may not perform as well as hoped, and high fees can eat into returns.
Ludovic Phalippou, professor of finance at Oxford Saïd Business School, last year published a paper that estimated the private equity industry had taken $230bn in performance fees from funds raised in 2006-15, but had only generated returns roughly equal to that of a cheap index fund that tracks smaller stocks.
Some analysts say the torrential inflows are at least partly helped because private market strategies appear superficially less volatile than those in public markets, as valuations are typically tabulated quarterly and enjoy some discretion.
Others argue the primary attraction is that it indirectly allows investors such as pension plans and insurers to use borrowing to enhance their returns.
“If I suggested that public equity shareholders should leverage their portfolios, I would be dismissed as being irresponsible and reckless,” said Lord Paul Myners, a City of London grandee.
“And yet the owners of public portfolios are very happy to have embedded leverage within their portfolio [by investing in private equity funds]. They don’t regard that as anything odd at all. The embedded debt in private equity is concealed.”
Moreover, some rivals to the private equity industry say the volume of money gushing into private capital will inevitably erode returns, known as alpha.
“Private equity cannot continue to have a lot of alpha, given how it has grown,” said Sandy Rattray, chief investment officer of Man Group, a hedge fund manager. “The consensus view is clearly just to put more money in private equity, but I’m not sure I quite buy that.”