Capital continues to pour into private markets

Fundraising remained active in the second quarter, with U.S. buyout funds raising more than $81.5 billion combined.

The year got off to a faster start than 2018, with $160 billion raised to date, compared to $86 billion in the first six months of 2018. Fundraising picked up in a big way during the fourth quarter of 2018, with $108.8 billion raised, and has remained strong since.

“It’s pretty astounding the amount of capital that’s being raised,” said Justin Storms, a partner with Debevoise & Plimpton’s investment management group. “In some ways, it is a little bit surprising, just because of the pricing in play in the North American PE markets, particularly from a buyout perspective.”

GPs are coming back to market faster, afraid of missing out on a good fundraising market environment, said Christian Kallen, a managing director at Hamilton Lane. GPs are also keen to refill their war chests in the event that a market downturn causes lean times.

“GPs want to have a fresh, newly raised fund, with a five-year investment period still outstanding so they don’t get caught in a market environment where it’s getting really tough to raise,” Kallen said.

Between new LP entrants into PE, existing investors increasing their allocations, and a strong distribution environment freeing up capital for re-commitment, LPs continue to pour money into GP’s coffers, said Natalie Walker, a managing director at Stepstone Group.

How to get to ‘no’

The speed at which GPs have come back to the market, in part to take advantage of high demand, has fractured some LP-GP relationships. LPs, already taxed by faster timetables for re-up commitments to core managers, have walked away from newer relationships if the GP comes back to market before proving a track record through a fully mature fund, Walker said.

“I think there is an assumption out there from the GP’s perspective that if they’re out of capital, they can justify fundraising and coming back to market, but that’s not always the case,” Walker said. “We’re actually seeing LPs walk away from relationships, citing time back to market as one of the reasons.”

Race to the middle

A few very large funds raised capital in the second quarter, including Blackstone Capital Partners VIII, which is seeking more than $22 billion; and Advent International GPE IX, which has raised $17.5 billion. But there is more activity and competition in the middle market.

The largest managers are still pulling in money, even if they’re not in the market with a flagship fund, offering spinoff products, separate accounts or co-investments, said Kallen of Hamilton Lane.

Larger GPs have had success raising lower-middle-market funds alongside their flagship products, Kallen said. At those firms, smaller funds allow a next generation of talent to get experience leading deals, and it allows those big firms to maintain pipelines for smaller deals even as their main funds outgrow them, he added.

Looking for safe returns

With many investors preparing for a downturn within the next two years, there is continued demand for strategies seen as less risky, said Sarah Sandstrom, a partner with placement agent and secondaries advisory firm Campbell Lutyens.

“It seems that investors are increasingly focused on managers that are well poised to capitalize on economic uncertainty in a downturn, and that can take several different forms,” Sandstrom said. “Some are focusing on managers that have really had experience performing well across multiple cycles, and we’re seeing more interest in healthcare and other types of strategies that performed better through the financial crisis.”

Risk-averse LPs are also increasingly looking for GPs that have shown more consistent returns, rather than GPs that mix a few home runs along with under-performing deals.

“If there is some volatility in their returns, it seems harder for LPs to really get behind those managers,” Sandstrom said. “There’s such a strong bias for the more consistent strategies that I think there is a risk that some outperforming strategies might be overlooked.”

A rush to risk-averse strategies creates new risks, though, as prices for “safe” companies reach ever higher, Kallen said.

“You have less operational risk with those companies, but you have much more financial risk now embedded in those kind of companies, given that the market is pricing those kinds of assets to perfection, and some would argue even beyond that point,” Kallen said. “On an asset basis, you may have a good recession-resistant business, but the deal structure pretty much takes that away again from you.”

Correction: This report was updated to change Sarah Sandstrom’s title to partner.