A New Era of Scale in the Private Capital Markets

Observing the accumulation of assets by the major players in the private capital markets and the growing number of megafunds being raised, many wealth advisors are asking valid questions about what’s driving this expansion and how it will impact the industry. Indeed, the world’s largest private capital fund managers have reached a scale today that would have been hard to imagine a decade ago.

The top 20 managers by size currently control about $1.6 trillion in capital, or almost 30% of total global private fund assets, including dry powder. To put that in perspective, this group represents only a fraction of 1% of the more than 10,000 private fund managers in the world, and their combined assets under management today is 70% greater than the entire industry managed 15 years ago.

The growth of these large firms and the concentration of private capital into their funds has been propelled by a number of factors. One of the main drivers has been their expansion across private asset types, including credit, real estate and infrastructure. For example, according to Preqin data, while the amount of private equity AUM grew almost fivefold from 2004 to 2018, the amount of capital targeting private infrastructure increased 29x, natural resources grew by 14x, private debt by almost 10x, and private real estate by nearly 8x.

The Big Get Bigger

The major firms that had the strategic vision to aggressively diversify were able to take advantage of their existing networks of institutional investors and their brands to attract senior talent and, in many cases, acquire entire teams from competitors to accelerate their entry into new markets. Their strong balance sheets and large back offices also allowed them to quickly ramp up multiple initiatives at once. In other cases, private capital firms that were early leaders in sectors that took off, such as technology and infrastructure, have become exponentially larger just by riding a massive wave.

Many of these firms have also become more professionalized, with improved risk management capabilities and more sophisticated infrastructure. As they’ve become more institutional in nature, they’ve built databases for prospecting, implemented formal processes around deal sourcing and due diligence and, in many cases, prepared succession plans to secure the next generation of leaders. Their investment committees also routinely evaluate aggregate exposure across industries, asset types and geographies and, in many cases, they’ve hired chief economists to help further sharpen their understanding of the potential effects of macro events.

Larger Players, Larger Deals

On the flip side, this expansion is adding to the increase in dry powder and overall capital in the market, particularly as these firms raise ever larger megafunds ($5+ billion in size). In fact, the $5 billion threshold for a megafund seems almost small these days given the number of funds with $10 billion or more being raised each year.

Megafunds represented just over half of the $235 billion raised by buyout funds that held closings in 2018 and their share of the total buyout dry powder rose to 46%, per Preqin data. This trend is driven by numerous factors, including the need by larger institutional investors to deploy capital into funds with scale and the increase in private transaction deal sizes. In 2018, PE firms completed more buyout deals worth at least $1 billion (119) than any year since the financial crisis.

The larger megafunds also are targeting the public markets for take-private opportunities. The total dollar volume of take-privates rose to $112 billion in 2017 and was just shy of $80 billion in 2018. While these large transactions accounted for less than 2% of the total number of buyout deals from 2016 through 2018, they accounted for 21% of the total amount of buyout deal value during that period.

Opportunity for Performance

The megafunds raised since the financial crisis have thus far performed well as a group. Because they tend to target larger, often more stable companies that generate significant cash flow, some would argue that they generally represent a safer bet.

The largest private equity firms point out that there is less competition at their end of the market simply because there are fewer funds that can write such large checks. According to a 2018 McKinsey report, megafunds, on a pooled basis, have outperformed their large-, mid- and small-cap counterparts since 2008. However, the highest returns still are being generated by small and midsize funds.

Of course, a likely consequence of the industry’s new scale and the significant amount of dry powder is that overall returns will decline on an absolute basis. In fact, we’re already seeing this happen. A 2019 Bain report cited data showing recent mature buyouts over the first half of the last decade generating a gross pooled multiple-of-invested-capital well below the earlier 2001-2004 period when there was less private capital competing for deals.

However, while overall returns likely will fall on an absolute basis for funds across all size ranges, private equity still is expected to continue delivering a significant premium over public markets, if for no other reason that PE managers enjoy an inherent advantage of being able to execute long-term strategic plans — something most public companies struggle with under the pressure of generating short term results.

Moreover, when the next downturn does occur, private equity-backed companies with diversified business lines and access to capital are arguably well-positioned to weather the storms and take advantage of dislocations in their markets.

Nick Veronis is Co-Founder and Managing Partner of iCapital Network, where he oversees research and due diligence.