Title: The Changing Landscape of Private Equity: Consolidation and Challenges Ahead
Introduction:
Private equity markets are experiencing a significant shift, as higher interest rates, fundraising difficulties, and rising regulatory costs contribute to a wave of consolidation. According to David Layton, CEO of Partners Group, the number of private market fund managers is expected to decrease dramatically over the next decade, with only around 100 major players remaining. This article examines the factors driving consolidation in the private equity sector and explores the challenges and opportunities that lie ahead.
The Wave of Consolidation:
1. Fundraising Pressure in Economic Turbulence:
– Tougher economic conditions have led to fundraising challenges for many private equity (PE) managers.
– Smaller managers are finding it increasingly difficult to attract new business in a crowded market.
– Wealthy individual clients are becoming a key driver of new asset growth, leading to a shift in strategy for some managers.
2. Natural Selection and Bifurcation:
– Larger PE managers have been able to secure a significant portion of new capital, leaving smaller funds behind.
– There is now a clear divide between managers who can raise money and those who struggle to do so.
– This trend will further accelerate the process of consolidation, reshaping the industry’s landscape.
3. Regulatory Costs and Reporting Requirements:
– Smaller PE firms face the challenge of higher legal and compliance costs due to new US reporting requirements.
– These costs disproportionately affect smaller businesses, adding an additional burden to their operations.
Challenges and Opportunities:
1. Integration Issues and Historically Failed Consolidations:
– Consolidation in the private equity sector has historically faced difficulties due to integration challenges.
– Culture clashes, executive pay disparities, and performance fee concerns have hindered successful mergers and acquisitions (M&A).
– However, companies are seeking new ways to grow assets, leading to a search for strategic distribution and investment capabilities.
2. Sustainable Organic Growth:
– M&A activity alone may not guarantee sustained organic growth.
– Adding asset classes, expanding geographically, and exploring new customer channels can complement M&A strategies.
– The real challenge lies in effectively translating consolidation into consistent and long-term growth.
3. Evolving Investor Preferences and Structures:
– Wealthy individuals are increasingly investing in private markets through new “evergreen” fund structures.
– These structures offer investment opportunities without a limited lifespan, providing increased allocations to private markets.
– Multi-asset class mandates tailored to the needs of institutional clients are gaining prominence as well.
4. Implications of Rising Interest Rates:
– The anticipated increase in interest rates has resulted in lower expected returns for private equity investments.
– Private equity executives, known as general partners or GPs, are facing tough decisions regarding debt-financed investments.
– The disparity in valuations between sellers and buyers adds complexity to pricing negotiations.
The Road Ahead:
1. The Outlook for Private Market Assets:
– Despite the challenges, Partners Group projects that assets in private markets will reach $30 trillion.
– Wealthy individual investors and institutional clients are expected to continue increasing their allocations to private markets.
2. Merger & Acquisition Opportunities:
– While a massive M&A spree may not be on the horizon, traditional asset managers may explore partnerships to broaden their investment capabilities.
– Alternative investment managers may seek access to larger distribution networks through such collaborations.
Conclusion:
The private equity industry is undergoing a significant transformation, with consolidation driven by various factors such as fundraising pressure, rising regulatory costs, and changing investor preferences. While challenges remain, such as integration issues and the need for sustained organic growth, opportunities arise through new investor structures and M&A strategies. The sector’s future will see a smaller number of major players shaping the landscape, with wealthier individuals and institutional clients continuing to allocate substantial capital to private markets.
Summary:
Private equity markets are facing a wave of consolidation, as higher interest rates, fundraising challenges, and rising regulatory costs reshape the industry. Smaller PE managers struggle to attract new business, while larger players secure a significant portion of new capital. Regulatory requirements and integration issues pose additional challenges. However, opportunities arise through new investor preferences, such as evergreen fund structures, and collaborations between traditional and alternative asset managers. The sector’s future will witness a smaller number of major players driving growth in private markets.
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The number of private market fund managers will shrink by up to 100 over the next decade as higher interest rates, fundraising challenges and rising regulatory costs push a massive wave of consolidation, according to a leading European private equity firm.
David Layton, CEO of Partners Group which oversees $142 billion in assets, said private markets have entered a “new phase of maturation and consolidation.” Managers responding to fundraising pressures in tougher economic conditions and turning to wealthy individual clients as a driver of new asset growth would drive a significant increase in mergers and acquisitions activity, he said in an interview.
“In reality, only the big players can resist the forces that are reshaping the private markets sector. We could see the current approximately 11,000 industry participants shrink to just 100 next-generation platforms that will matter over the next decade,” Layton said.
Assets held in illiquid private market strategies totaled $12 trillion at the end of December, according to consultancy Preqin. The firm estimated that total fundraising in private markets fell 8.5% last year to $1.5 trillion, with net inflows to private equity managers falling 7.9% to $677 billion in 2022.
Many smaller PE managers have found the process of attracting new business increasingly difficult. The 25 largest competitors have captured more than a third of the $506 billion in new capital allocated to PE so far this year.
“There’s a real bifurcation between managers who can raise money and those who can’t. This will accelerate the process of natural selection as the industry grows in size,” Layton said.
The main executives of the sector were predict the changing landscape in alternative asset management. Consolidation is already happening with deals like that acquisition this month by CVC of a majority stake in Dutch infrastructure investor DIF Capital Partners for around €1 billion in cash and shares.
Bridgepoint this month announced the purchase of Energy Capital Partners, a US-based renewable energy specialist, in a cash and share deal worth around £835 million.
Jon Moulton, founder of UK-based Better Capital, said “massive changes” were approaching given the difficulties faced by smaller PE funds in securing support.
“Institutional investors would much rather make a single $1 billion allocation to a large PE manager than subscribe to a stream of $100 million bills,” Moulton said.
All PE managers also face the prospect of higher legal and compliance costs due to new US reporting requirements, a burden that will weigh disproportionately on smaller businesses.
Hugh MacArthur, global president of Bain & Co’s private equity team, said PE consolidation has historically been “largely a failure” due to integration issues involving culture clashes, executive pay and performance fees . However, more and more companies were looking for new ways to grow assets.
“Adding asset classes to a broader platform, geographic expansion, new customer channels and strategic distribution are all tools to this end. The real challenge is translating mergers and acquisitions into sustained organic growth,” MacArthur said.
Layton downplayed the prospect of partners embarking on a merger and acquisition spree, but predicted more deals between traditional asset managers looking to broaden their range of investment capabilities and alternative investment managers needing access to networks of larger distribution.
Partners Group expects assets in private markets to reach $30 trillion, thanks to increased allocations by wealthy individual investors into new “evergreen” fund structures that do not have a limited lifespan.
The Switzerland-based firm also intends to offer more multi-asset class mandates that can be tailored to the needs of institutional clients.
Many PE managers secured debt on very favorable terms during the era of ultra-low interest rates. Impending debt refinancing needs could accelerate the consolidation process.
According to Partners Group, interest rate increases mean that expected returns for private equity investments have fallen by about 400 basis points. This could leave private equity executives, known as general partners or GPs, facing difficult choices regarding their debt-financed investments.
“Many of the sellers of private market assets are anchored to yesterday’s valuations while many buyers are saying ‘this is a new world.’ [for pricing]”Layton said.
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