Private equity titans warn attendees to expect lower returns

Titans of private equity shared some hard truths at the Milken Institute Global Conference: Returns now will be lower than investors had come to expect from the asset class; capital distributed back to limited partners will decrease; and their firms will be launching funds with lives as long as 20 years.

Speaking on a panel titled “Private Equity Outlook from Industry Titans,” Leon Black, chairman, CEO and director of Apollo Global Management; Jonathan Nelson, founder and CEO of Providence Equity Partners; David Rubenstein, co-founder and co-CEO of The Carlyle Group; and Robert Smith, founder, chairman and CEO of Vista Equity Partners kicked off Monday afternoon's discussion with a question from moderator Andrea Kramer, managing director of consulting and money management firm Hamilton Lane, on the asset class' biggest risks.

Mr. Black said private equity transactions are “priced to perfection” meaning they are highly priced. The average private equity deal of more than $500 million is selling at an 11 times multiple of earnings before interest, taxes, depreciation and amortization, he said. Before the financial crisis, private equity deals were selling for 10.5 times EBITDA.

At the same time, there is less debt available for private equity deals. The more equity invested in deals decreases returns, he said.

“It's tough out there,” Mr. Black said.

Even so, Apollo invested $5 billion in private equity — $3 billion from funds and $2 billion from co-investments — in the first quarter, he noted.

Mr. Nelson said that Providence Equity executives focus on companies likely to grow faster than gross domestic product.

“'Priced to perfection' is a nice way of saying overpriced,” Mr. Nelson said.

The presidential election is also a factor in the private equity market, Mr. Rubenstein said.

The markets have “built in a presumption that Hillary Clinton wins” the presidency, Mr. Rubenstein said; if another candidate wins, the markets will be “spooked.”

Meanwhile, private equity returns that had been an average of 15% historically are down to 12%, Mr. Rubenstein said: “I suspect that is where returns will stay.”

Most private equity firms already have sold all the companies they can over the past two years, Mr. Black said.

“We are at the planting and building stage” which means distributions will be lower than in the past few years, Mr. Black said.

All the panelists agreed that sovereign wealth funds are changing the private equity landscape.

Public pension funds are not as significant investors now as sovereign wealth funds, which are committing more capital than general partners have ever gotten before, Mr. Rubenstein said.

Sovereign wealth funds “want an enormous amount of co-investment,” and are happier with lower returns than other types of investors like public pension funds, Mr. Rubenstein said.

Vista Equity's Mr. Smith said there has been a “surge in demand from sovereign wealth funds.” Not only are they committing capital, but also they want to embed officials from the sovereign wealth fund with private equity firms to learn the business, he said. “We would not have seen that a year ago,” he added.

Sovereign wealth funds also are asking for investment funds with longer lockups so general partners can hold onto performing assets, Mr. Smith said.

“Good companies in a lower-interest-environment are hard to replace,” Mr. Nelson said.

Meanwhile, real estate managers and real estate investment trust executives speaking on a panel called “Real Estate: Where are Prospects Rising and Falling?” on Tuesday said their industry is in a better shape to withstand another downturn than before the financial crisis.

“There is limited new supply coming online,” said Michael Weil, CEO of AR Global Investments, the real estate manager formerly known as American Realty Capital.

However, this is not true everywhere.

There is oversupply in New York City, and the new construction in London is “freaky,” said David Simon, chairman and CEO of retail REIT Simon Property Group. But if there is a downturn, generally the “supply is not going to kill us,” he said.

Part of the reason there hasn’t been a great deal of new construction is that lenders have been stingy with loans, Mr. Weil said. “Lenders are more comfortable saying ‘no’ than ‘yes,’” he said.

Still, Mr. Simon said the retail sector is on the edge of getting more supply than it should.

There was some disagreement among the panelists regarding real estate investment in Brazil.

Pointing to the political situation and the large demonstrations against Brazil President Dilma Rousseff, Mr. Simon said it was too early to invest in the country.

“I like Brazil, but I think it’s a year away,” Mr. Simon said.

However, Barry Blattman, vice chairman and senior managing partner of real asset manager Brookfield Asset Management, also speaking on the real estate panel, said Brookfield is already investing in Brazil. Indeed, Brookfield has invested in a number of real asset sectors including agriculture, timber and infrastructure in Brazil.

“It gives us a window into what is important,” Mr. Blattman said.

Brookfield executives think the best opportunities are in investments in existing buildings in emerging markets, including China and India, Mr. Blattman said.