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The private equity industry’s capacity for leveraged buyouts continues to decline. Here are some reasons for this trend:
Monetizations of portfolio companies have been talking longer in recent years. That traps investors’ capital, reducing capacity for redeployment in new funds or in some cases for recycling in existing funds.
Newly launched buyout funds – even from established managers – are having an increasingly difficult time raising the same amounts of capital they did in earlier funds. Large institutional investors have been cautious on private equity due to liquidity constraints they encountered in 2008 as well as poor return expectations for the whole sector.
Many pensions and endowments are staying away from some of the mega-funds with the belief they are too bulky to achieve superior returns. And in cases where major investors do come into large LBO funds, they often demand to directly co-invest with these funds on buyout deals. These co-investments, on which pensions do not pay fees, become a significant portion of investors’ private equity allocations. Pensions holding company shares directly on their books limits the amount of capital available for LBO funds. Some years back when deals were too large for a single fund, LBO firms would call each other to club on transactions. Now they call their investors to present co-investment opportunities.
Another trend causing a slowdown in institutional demand for LBO equity funds – the largest among private equity products – has to do with the ongoing rebalancing in retirement funding. Increasingly employers are shifting from defined benefits to defined contribution pensions. Defined contribution accounts are managed by individuals rather than pension funds and do not have access to alternative investments such as private equity. The slower growth in defined benefits accounts (as well as the ageing population of employees with these benefits) limits the overall demand for private equity, making fundraising for LBO shops enormously challenging in an already competitive environment.
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