But deal prices are rising, which will leave some investors with smaller returns. Just last month, Kohlberg Kravis Roberts & Co., Bain Capital LLC and Merrill Lynch Global Private Equity joined in the $33 billion buyout of urban hospital chain HCA Inc. If the deal closes, it would be the largest buyout since KKR's $31 billion buyout of RJR Nabisco Inc. in 1989.
"In recent times, the megafunds have performed spectacularly. Everyone conversant in private equity knows that this is more "beta," due to capital markets and momentum in the marketplace, and these things don't last forever," said Gary Robertson, senior vice president at Callan Associates Inc., San Francisco. "All the things that have fueled the returns, including low prices after the recession, low interest rates and easy access to debt, are all beginning to turn now. Everything that caused the halcyon days in the buyout industry are beginning to get bumpy, but nobody knows when it is going to stop."
Monte Brem, president of PCG Asset Management, La Jolla, Calif., said he sees "a shift from the big brand-named funds to different parts of the buyout market. This (shift) occurred very recently. In the next 12 months you'll see a decrease to megabuyout funds."
In June, for example, five university endowments made commitments to JH Partners' second midmarket private equity fund, which closed with $350 million. The five — the $25.9 billion endowment of Harvard University, Cambridge, Mass.; $6.7 billion Massachusetts Institute of Technology endowment, Cambridge; $11.2 billion endowment of Princeton University, Princeton, N.J.; $15 billion endowment of Stanford University, Palo Alto, Calif.; and $5.2 billion Yale University endowment, New Haven, Conn. — also invested in the firm's first fund.
Midmarket buyout firm Catterton Partners, Greenwich, Conn., closed the $1 billion Catterton Partners VI in 10 weeks, said J. Michael Chu, managing partner and co-founder. The lead investor is AlpInvest Partners, the private equity firm owned by two Dutch pension funds, the €196 billion ($251 billion) Stichting Pensioenfonds ABP, Heerlen, and the €71 billion Stichting Pensioenfonds PGGM, Zeist. Other investors include the $54 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, and the $13.8 billion New Mexico State Investment Council, Santa Fe.
The shift in focus does not mean institutional investors are losing their craving for private equity overall; most are below their target allocations by 75% to 85%, said Michael B. Smith, senior consultant, Russell Investment Group, Tacoma, Wash. The average strategic allocation to private equity is forecast to be 7.6% in 2007, up slightly from 7% two years earlier, according to a biennial Russell survey. And in 2005, the most current Russell data available, investors made two-thirds of their commitments to buyout funds, compared with 20% to venture capital funds.
"Some of the very largest investors really don't have a choice," Callan's Mr. Robertson said. "If they are going to get fully invested, this (large buyouts) is the key strategy they have to focus on, out of practicality and necessity."
"It seems to me there will be a slowdown because there will be fewer (megafunds) that will be raised," said Joe Dear, executive director of the $66.9 billion Washington State Investment Board, Olympia, Wash.
Most of the top buyout managers that could handle a megafund have already raised funds. In the first half of this year, 73 buyout funds raised $54 billion, according to Thomson Financial and the NVCA. Most of the capital was committed to about 10 jumbo funds, including Texas Pacific Group's $14 billion TPG Partners V; The Blackstone Group's $15.6 billion Blackstone Capital Partners V; the $6.5 billion Madison Dearborn Capital Partners V; and the $10 billion Bain Capital Fund IX.
Mr. Dear said the slowdown in megabuyout fundraising does not change the investment board's strategy. Earlier, Washington committed up to $1.5 billion with long-time partner Kohlberg Kravis Roberts' KKR 2006 Fund and up to $750 million to Texas Pacific Group's TPG Partners V.
Officials at CalSTRS and the $205.8 billion California Public Employees' Retirement System, Sacramento, expect to make bigger commitments to fewer funds.
The buyout category will remain the largest portion of CalPERS' private equity portfolio, said Brad Pacheco, CalPERS spokesman. Of the fund's $26.5 billion in total private equity commitments as of Dec. 31, some $11 billion, or 40%, was in corporate restructuring and $2.5 billion, or 9%, in buyouts; fund officials consider the restructurings as part of a broader buyout category. That compares with $3.1 billion in venture capital, $449 million in mezzanine debt and $1.3 billion in distressed securities.
However, whether CalPERS invests in megafunds or the small and midsize end of the buyout market will be determined by who is in the market fundraising, Mr. Pacheco said.
Currently, there are some relatively large midmarket buyout and distressed debt funds in the market, including MatlinPatterson Global Advisers LLC, which is targeting between $3 billion and $3.5 billion for a distressed debt fund, sources say. Bear Stearns just finished raising $2.7 billion for a midmarket private equity fund last week.
"You can look for CalPERS to make larger commitments to fewer funds that give us good diversification," Mr. Pacheco said.