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Private equity firms are sitting on an ungodly amount of capital after mammoth fundraising in 2020-21 and small investments in subsequent years.
Late last year, Preqin estimated the amount of “dry powder” at more than $4 trillion, nearly a third of the entire private equity industry’s total assets under management. As Alphaville wrote in May, the industry has now taken in more money from investors than it has returned in six straight years, for a gap of about $1.6 trillion.
Analysts at Morgan Stanley reckon that the proverbial dry powder pile has now grown to around 4.5tn – which, with leverage, means it’s sitting on roughly 9tn of purchasing power – and that it will need to be really invested soon:
Deployment time (dry powder compared to annual deployment) increased to ~3 years, the most since 2013 and above the levels seen over the past 5 years at ~2.4 years for deployment. With large fundraisings in 2020-21 and limited deployments over the past 2 years, we now see an aging cash pile of private equity dry powder, which in some cases may begin to generate economics if not deployed, creating an urge to transact. .
That was also a bit of a theme on some of the industry’s second-quarter conference calls, with Partners Group CEO David Layton noting that “you use it or lose it over a period of time.”
But where? Most of the money is in private equity funds, and despite the prayers of investment bankers, activity remains muted. By dollar value, PE-backed M&A grew 32 percent year-over-year in the first half of 2024, but remains weak relative to history and the growing size of the industry.
And according to the number of stores, the activity continues to shrink. If you discount the first half of 2020 — because, well, obvs — we’ve seen the fewest trades in the last six months of 2023 and the first six months of 2024 since 2017.
Unfortunately, Morgan Stanley doesn’t really have anything actionable to say about where that money is going, only observing that private credit opportunities, refinancing of existing deals, opportunistic “dislocations” and hot topics like green energy and artificial intelligence. .
Here are the bank’s “key deployment themes”:
1. Expand across the private credit spectrum. Alts mgrs continue to enter a lender friendly environment with attractive risk/rewards. Opportunities range from sponsor-backed lending, CLOs to asset-backed financing, various forms of bank partnerships and more. We continue to see opportunities emerging for banks in asset portfolio sales, regulatory capital deals and forward flow arrangements.
2. Bring liquidity and flexible capital solutions. We see alts mgrs continuing to be adept at bringing in a range of liquidity solutions (ie LP/GP led secondary products, continuation vehicles, hybrid equity) given limited distributions and executions. Demand for refinancing is also strong, with servicers providing structured refinancing solutions and providing a bridge to falling rates.
3. Enter selective dislocation pockets. Alts mgrs selectively target areas of dislocation that represent compelling valuations, particularly across distressed real estate asset classes. Some point to low real estate values, which present opportunities to buy topics such as warehouses, student housing, apartment rentals, logistics, European real estate, etc. Global Foundation
4. Lean on highly-convinced LT themes and markets undergoing structural change. The focus is on secular themes (ie energy transformation, data centers, logistics, AI, digital infrastructure) with resilient growth profiles and long-term challenges. As markets go through structural changes, such as in Japan, which is ending a decade of deflation, we see greater risk appetite and shareholder activism. This prompts businesses to reassess their strategic options and portfolio of businesses, and can be a catalyst for spin-offs as well as takeovers of private companies by public companies.
In other words: ¯\_ (ツ)_/¯
But basically everyone agrees that the current situation—where private equity funds are scrambling to raise new funds but are not deploying their existing capital, realizing many of their investments, or returning returns to investors—cannot last much longer.
Morgan Stanley’s own CEO Ted Pick talked about this in the bank’s earnings call on Tuesday, noting that:
. . . there was just so much activity that was suppressed by any measure of percentage of assets, of shares, of percentage of market capitalization. And the stickiness that we see even in the sponsor community needs to be unglued. There’s a huge, as you know, trillions of dollars of inventory between the two sides — they’re sitting on the inventory that needs to be released and then the dry powder that’s been acquired.
Given the scale of money that can be put on the line when things finally “unstick,” the only people happier than investment bankers might be financial journalists who love dumb deals. 🍿