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Earlier this week, MainFT reported that hedge funds are struggling to figure out how much money investors have locked up in private equity funds — which generate no returns.
As Michael Monforth, global head of equity advisory at JPMorgan Chase, told our colleagues:
Lower rate of distribution from private equity, [private] debt and hedge funds have a ripple effect, leading some allocators to suspend new investments in illiquid funds and reduce new investments in more liquid hedge funds.
But this got FT Alphaville wondering: how big is the gap between the money requested by private equity firms and the realized returns they actually recycled back to investors? So we asked Preqin for the data and, friends, it’s absolutely massive.
Private equity firms took more money from investors than they gave back as profits six years in a rowfor the total gap 1.56 tons for this period.
And it’s not just the recent excess of raised capital, delayed returns and private equity exit blockages. Even when you include the big returns from 2013-2017, private equity funds have now called in $821 billion more than they returned over the 14 years Preqin’s data series spans.
You might think that in a ruthless, meritocratic industry like private equity, this might have had an impact on compensation? Ahahaha no, of course not you sweet child.
FTAV looked at the labor and equity compensation costs of the largest listed North American private equity players, totaling over $100 billion over the past five years.
There’s a reason why Oxford finance professor Ludovic Phalippou called the industry a “billionaire factory” in a landmark 2020 paper examining private equity returns.
U.S. PE funds raised $1.7 trillion between 2006 and 2015, generating $230 billion in carried interest and providing investors with an overall net performance equal to stock indexes and small-cap mutual funds). Most of this money goes to the largest PE firms, and within the largest PE firms, most of the money goes to a few partners, often the founders. At least that was the model until a few years ago. First, the four largest PE firms went public in late 2000. Since then, the Carry they earn (as well as other fees) is distributed to their shareholders (including the founders). Furthermore, in the past few years, some private equity funds have bought stakes in private equity firms, paying existing shareholders (mainly the founders of these firms) large sums of money to gain access to a share of their future stream. fees and Carry. These transactions have resulted in many PE firm founders becoming multi-billionaires. Many founders who haven’t sold a portion of their PE firms are probably also multi-billionaires, but haven’t realized that value and therefore don’t show up in the multi-billionaire rankings.
Of course, these things move in cycles. Naturally, there are years when more money is withdrawn than returned. And maybe the trillions raised in the last 4-5 years will eventually come back to investors many fold over the next decade.
But the fact that private equity alone has a record backlog of 28,000 companies worth an estimated $3 trillion at a time when most stock markets are at or near record highs does not fill a person with self-confidence. There’s a reason PE and VC fund shares are sold at often steep discounts.
There appears to be too much of a mismatch between what private equity and venture capital have paid for many assets, the returns their investors expect, and what the public markets or other potential buyers are willing to pay.
And as long as that remains true, it’s going to be a long, hard case of investor malaise to deal with. After all, NAV loans will only take you so far.
Further reading:
— Does private equity really pay off? (FTAV)
— Private Valuation Review (FTAV)
Private Equity Industry ‘Dry Powder’ Hits $4 Trillion (FTAV)