With so much going on in the markets — quantitative easing abroad, continuing calls for belt-tightening here, the kickoff to the presidential sweepstakes, a rising dollar, the collapse in oil prices — perhaps it's not surprising some pundits are proclaiming the death of private equity as an asset class.
Nothing could be more naïve.
In fact, I am reminded of a 1975 BusinessWeek cover that famously pronounced the death of stocks right before a 20-year bull run. As we know, equities didn't die – nor will private equity.
Then why has so much been made of the fact that $266 billion was raised by U.S. private equity funds last year and what that might mean to the future of the industry?
By way of background, private equity firms typically manage capital in a limited partnership structure that has a 10-year partnership life. Firms typically invest their capital into new investments over a three- to five-year period with the expectation of maintaining an ownership position in these businesses for three to five years before the portfolio company either completes an IPO, or is acquired by a strategic or financial partner. Based on that timeline, a firm that raised capital in 2014 might invest in a privately held business in 2018 and look to sell or take that business public in 2022.
While certain dynamics (competition for deals, readily available debt, etc.) in today's private equity market might present challenges, I think most will agree it is premature for anyone to accurately predict, in early 2015, what private equity returns will be for capital that was raised by firms in 2014. One must first be able to accurately predict what market conditions — including macro-economic and private equity — will be in 2018 when the initial investment is made, what the broader market conditions will be during their four years of ownership, and in 2022 when the company looks to exit. This is a difficult, if not impossible feat.
I have been involved in the private equity industry since 2001. During this time, I have had numerous conversations with the founding general partners of some of the most successful private equity and venture capital firms in the world. These individuals all had significant private equity experience, had raised multiple private equity funds and had lived through multiple market cycles. A question I like to ask is whether they knew, at the time they were raising capital, which vintage year fund would be their best performer. None of these individuals has ever claimed to know what vintage year would produce the best returns. Why? Simply because a lot can happen over a 10-year partnership life.
Due to the difficulty of predicting returns, many institutional investors have implemented a private equity program with regular and consistent exposure to each vintage year in the hope of smoothing volatility of returns. This strategy has worked very well for endowments, foundations, corporate pension plans and public pension plans. These groups are active and regular participants in the asset class because of the return potential it provides for their portfolio. They have accepted the fact that, much like all of the other markets, attempting to “time the market” is a dangerous game.
The question of, “Is now a good time to invest in private equity?” is always a difficult one to answer. Private equity is a broad term that covers a variety of different investment strategies (leveraged buyout, special situations, venture capital, mezzanine, etc.); various industries; and various size companies. At any given point, there are always areas of private equity that are very attractive and other areas that are not very appealing. The reasons for this include valuations, sector dynamics, regulatory issues and competition. So, the answer to the question is always: “It depends on where you are deploying capital.”
So, does the amount of private equity capital raised in 2014 present some potential challenges to the market?
Yes.
However, many private equity professionals have lived through times like this before. They will maintain their valuation discipline; they will be conservative with the amount of leverage provided to their companies; and they will offer resources, advice, support and investment dollars to these companies during their ownership. They also will work with top management talent, will advise these companies on an IPO or M&A deal, and will seek to provide attractive returns to investors. For these firms, private equity is far from dead.
Kevin Campbell is managing director, private markets, at DuPont Capital Management.
