The highly publicized bankruptcies of private equity-backed companies such as Toys R Us Inc., Claire's Stores Inc. and Southeastern Grocers LLC are confirming, for some investors, the move away from classic leveraged buyout investments.
Falling expected private equity returns started investors down the road toward alternative private equity investment strategies. Some 40% of investors expect private equity to provide returns of at least 4.1 percentage points above the public markets, down from 54% in 2012, according to a December investor survey by London-based alternative investment research firm Preqin. Indeed, U.S. buyout funds provided a 17.3% net internal rate of return in 2017, underperforming the S&P 500 index's 17.9% return, according to Bain & Co.'s annual private equity report. In fact, U.S. private equity underperformed the S&P 500 for the one-, three- and five-year periods ended Sept. 30, but exceeded it for the 10-year period by slightly more than 2 percentage points.
Despite the recent headlines, the number of bankruptcies of private equity-backed companies fell sharply in 2017. Before 2017, portfolio company bankruptcies had been rising or staying flat since 2012, according to PitchBook. Through March 27, 15 private equity-backed companies have filed for bankruptcy this year. In all of 2017, 76 such companies filed for bankruptcy, down from 122 in 2016, according to PitchBook.
This does not necessarily mean portfolio companies are healthier.
The decline in bankruptcies can be attributed "to various drivers, such as a relatively healthy economy and easily accessible debt to delay principal repayments," said Dylan Cox, PitchBook's private equity analyst.
In addition, "potentially problematic private equity investments" have been boosted by low interest rates, an active merger-and-acquisition market and covenant-light debt used in the pre-financial-crisis deals, said David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC.
Even so, with private equity returns expected to slide downward due to the large amount of capital flooding into the asset class, many asset owners are looking for other, lower-fee ways of accessing private equity, sources said.