New gang gives A-list private equity firms run for their money

Updated with correction

Move over KKR, Blackstone and Bain Capital. There is another group of private equity firms edging you off of investors' must-have lists.

The new A-listers include KPS, Sentinel and H.I.G. Capital, consultants and industry insiders say.

To be sure, the big dogs are starting to close private equity funds, after a year or more of fundraising. But they are doing so after making concessions — some for the very first time — and trimming the size of their fundraising targets.

Earlier this year, KPS Capital Partners LP closed on a $3.5 billion fund — its fourth fund — in record time. It took only three months from the start of fundraising to final close. It did this despite gathering about 75% more capital than its $2 billion third fund and a fee structure that gave it lower management fees but higher carried interest — up to a whopping 30%. The typical carry fee, which reflects a percentage of the profits, has been about 20%.

In July, Sentinel Capital Partners LP held a first and final close of its $1.3 billion fund, Sentinel Partners V, well above its $1.1 billion target and the $765 million fourth fund, after only four months of fundraising. Investors in the fund include the $1.1 billion El Paso (Texas) Firemen & Policemen Pension Fund, the $25.7 billion Pennsylvania State Employees' Retirement System, Harrisburg, and $3.8 billion Houston Police Officers' Pension System.

“Investors are less seduced by Carlyle and more by middle-market firms like KPS,” said one consultant, who spoke on condition of anonymity.

Investors are looking for high-quality managers, so middle-market firms are getting some attention, said Todd Miller, Dallas-based managing director at private equity secondary market brokerage firm Cogent Partners.

Small to midmarket buyout funds are the most desired fund type by global private equity investors, said Nicholas Jelfs, senior analyst and press officer with London-based alternative investment research firm Preqin. (Preqin defines small buyout firms as those with funds of $500 million or less; middle market, funds with $501 million to $1.5 billion; large, $1.5 billion to $4.5 billion; and megabuyout, funds of more than $4.5 billion.)

Sixty-six percent of global institutional investors believe small to midmarket buyout funds now offer the best investment opportunities, compared with 15% that said large to megabuyout vehicles offered the best opportunities, according to the results of a soon-to-be released investor survey conducted this month by Preqin.

One of the drivers of that sentiment is performance. While large and megabuyout funds have generally outperformed small and midmarket funds over a one- to three-year horizon, for the longer time frames, small- and midmarket funds have outperformed, Mr. Jelfs wrote in an e-mailed response to questions.

The median return for megafunds for the year ended March 31 was 14.6%, compared with 10.3% for large, 10.2% for midsize and 14.4% for small funds, according to Preqin. The median return for the five-year period ended March 31 was 7.4% for megafunds and 6% for large funds, compared to midsize at 7.7% and small at 9.4%, Preqin data show.

There is a small group of midsize firms whose funds are highly prized on the secondary market because their funds have outperformed in the past, said Peter McGrath, president of Toronto-based Setter Capital Inc., a secondary market broker. The belles of the secondary ball include ABRY Partners, Charlesbank Capital Partners, Audax Group and American Securities LLC, he said.

Some investors consider desirability of funds on the secondary market “as a leading indicator of the best funds to invest in because they are so highly sought after,” Mr. McGrath said.

But that doesn't mean investors are shunning the megafund firms.

“Firms like Bain Capital and Blackstone are like Coca-Cola and IBM. They are safe ports of call. People have a strong belief in their funds,” Mr. McGrath said. “Still, people who want to outperform the blue-chip names will go into the middle market.”

Indeed, Carlyle Group LP had its second-best fundraising period ever across all of its strategies, including private equity, raising $22.9 billion in the 12 months ended Sept. 30. In its latest earnings report, Carlyle noted it has raised close to $13 billion for its newest private equity fund, Carlyle Partners VI, surpassing its $10 billion target after about 18 months raising the fund. Carlyle spokesman Christopher Ullman declined to comment. (Carlyle closed its last buyout fund, Carlyle Partners V, in 2007 with $13.7 billion.)

Mario Giannini, CEO of alternative investment consultant and money manager Hamilton Lane, Bala Cynwyd, Pa., believes most of the private equity capital being raised is with the name-brand firms. Despite all the new kids on the block, there is more capital flowing to mega firms than any of the other groups in the market, he said.

Some big investors are sticking with the well-known firms. The $274.8 billion California Public Employees' Retirement System, Sacramento, has a $31.4 billion private equity portfolio. While it has made very few private equity fund commitments recently, much of the capital committed in the first nine months of this year has gone to large private equity firms. These commitments include $649.9 million to CVC European Equity Partners VI, $547 million to Carlyle Partners VI, $575 million to KKR Asian Fund II, $500 million to Apollo Investment Fund VII and $400 million to Silver Lake Partners IV.

Private equity funds of mega firms like Carlyle and Apollo Global Management LLC are near oversubscription, Mr. Giannini said.

As of Sept. 30, Kohlberg Kravis Roberts & Co. LP had raised $8.3 billion for its newest large private equity fund, KKR North America Fund XI LP, which has a target range of $7 billion to $8 billion, said Scott Nuttall, member and head of global capital and asset management group during KKR's third-quarter earnings call. But the firm has been raising the fund for more than two years.

Plus, KKR last year lowered the fund's target from up to $10 billion, and it is the firm's first private equity fund to include a performance hurdle requiring KKR to return 7% to limited partners before the firm can receive its 20% share of net profits, according to SEC documents.

KKR's last U.S. buyout fund was the $17.6 billion KKR Fund 2006. In July, it raised the largest-ever pan-Asia private equity fund, the $6 billion KKR Asian II Fund.