The Pulse of Private Equity – 3/7/2016

How Will Competition Among Fund Managers Affect Future Industry Performance Disparity?

Post-recession private equity funds experienced a tightening of IRR spreads across several different vintages, as fund managers of all tiers weathered the economic downturn. 2010 and more recent vintages, however, have seen a widening of the spread. This is partially attributable to how intense the dealmaking environment has been as of late, as well as a consequent delay in deployment, which in turn has depressed IRRs of certain recent vehicles. But how much further could these spreads widen in the coming years? Given the preponderance of capital overhang in the PE industry, as well as the sheer number of firms competing to put that overhang to work, it’s reasonable to expect a fairly sizable disparity in performance going forward, although if the healthy seller’s market persists, then all quartiles may shift upward by a minute degree. The timing of such shifts, however, is likely to be prolonged. The level of competition is unlikely to slack, armed as general partners are with plenty of dry powder, and as uncertainty around prospective economic growth continues unabated, sustained quantitative easing may well keep asset prices at relatively high levels. These factors combined will discourage substantial investment levels, leaving only top-tier performers with strong track records and ample supplies of dry powder able to win competitive auctions and, moreover, exit at robust multiples, while broad swathes of the PE investor population may well see delays in their pace of investing and selling. Accordingly, the spread of performance is likely to remain wide for some time, until more recent vehicles are able to deploy capital in ever-more specialized strategies and potentially experience short-term upticks in IRR performance. Perhaps then, as time wends on, the performance gap will shrink somewhat, with general IRR quartiles tightening, much as seen in vintages prior to 2010.