Year-End Fundraising Wrap-up: The Adoration of the Mega

U.S. private equity firms are poised to raise more money than in any year since the global financial crisis, thanks in no small part to limited partners pouring massive amounts of capital into the largest funds available to them.

The U.S. PE industry raised more than $201 billion through Dec. 11, surpassing the total it raised the year before by almost $5 billion and setting the stage for another blockbuster total by year-end.

The bulk of what was raised went to the industry’s largest buyout funds. Through Dec. 11, megafunds targeting $5 billion or more had raised $84.3 billion — more than in any year since 2008. Apollo Global Management hauled in $24.6 billion in the largest traditional fundraise in PE history. Historic firms Bain Capital and Clayton Dubilier & Rice collected $9.4 billion and $10 billion, respectively.

LPs have good reason to step up their allocations to the largest players in the market. While small and mid-market private equity firms are typically pitched as offering more upside than their multibillion-dollar counterparts, the median return generated by megafunds is actually slightly higher than that of small and mid-market vehicles, Hamilton Lane data shows.

“We think of megas as a nice, stable base to invest around,” said John Stake of Hamilton Lane.

That said, Stake said his firm is spending considerable time assessing opportunities among funds raising $1 billion or less. Other LPs are following suit: Firms raising vehicles targeting $999 million or less raised $38.6 billion through Dec. 11, compared with $35.8 billion throughout all of 2016 and $31.6 billion in 2015, according to Buyouts data.

The mid-market “just has so much capital in it right now,” said Mike Elio of StepStone Group, speaking on a panel at Buyouts Insider’s PartnerConnect Southwest conference. “It just becomes a harder diligence process. That said, if you can slog through it, there can be some great stuff down there.”

In some respects, the amount of capital flooding toward larger fund managers is spurring the launch of smaller spinout firms with smaller targets and more concentrated strategies, multiple sources told Buyouts. As larger GPs pursue bigger deals upmarket, certain dealmakers on their teams will leave to continue working on smaller transactions.

“I am seeing no slowdown at all in terms of new fund formation,” said Scott Reed of Aberdeen Standard Investments. “I can think of numerous instances in the last couple weeks where we learned about a new spinoff or spinout or new situation.”

LPs are showing particular interest in specialized strategies: A majority of North American LPs surveyed by Coller Capital said they preferred managers who offer a single product or investment strategy.

While smaller vehicles benefited from the focus on specialization, so did larger managers like Silver Lake and Vista Equity Partners, both of which raised $10 billion-plus vehicles for investments in software and technology companies.

“As the asset class has matured, it’s given rise to more specialized strategies,” Reed said.

Trouble on their minds

Even as distributions from private equity funds boost the overall return of their portfolios, limited partners face significant challenges in deciding which managers to back in the current fundraising environment. Given the level of investor demand, firms are raising more money, faster than at almost any point since the financial crisis, according to Preqin data.

This is encouraging some managers to raise new funds sooner than expected, forcing LPs to make difficult decisions about their allocations and exposure, multiple sources said.

“What bothers us is the number of the firms that are coming back early,” one LP told Buyouts. “Good managers you want to re-up with; you’ve got a lot of dry powder left and you still want to raise a new fund?”

Capital from sovereign-wealth funds, some of which are only recent investors in private equity, is also contributing to a crunch in the LP universe. Top-performing firms are in a position to dictate terms and allocation sizes to their investors.

“It’s actually frustrating for people who used to be in the catbird seat, like endowments and foundations, who used to be able to set terms,” said an investor-relations professional at one multibillion-dollar PE firm.

In a market overview provided to investors, Hamilton Lane indicated its outlook for private market assets is relatively neutral and urged LPs to show a healthy level of caution. Investors who shell out oversized commitments to maintain their targeted asset allocations to private equity may wind up overextended.

“Maintain your commitment pacing in the private markets,” the firm wrote in its market overview. “Yes, that’s boring, but don’t reach for allocation levels. If you drop below, let it go. Go to the beach. Take a vacation.”

With the winter holidays approaching, LPs should especially heed the last two points.

The Peak 2 Peak gondola passes between Whistler and Blackcomb mountains in Whistler, British Columbia, on Dec. 11, 2008. Photo courtesy Reuters/Andy Clark

Update: The story was updated to reflect the rebranding of Aberdeen Standard Investments from its previous name, Aberdeen Asset Management, following the completion of its merger with Standard Life in August. 

Additional Data

Amount raised through Q4 2017 by fund type ($B)

FUNDS RAISED IN Q4 2017

Largest fundraisers in 2017 YTD

LBO funds raised by target size through Q4 2017 ($B)

Q4 2017 Playbook for Select LPs

Quarterly breakdown of amount raised by U.S.- based buyout and mezzanine firms ($B)

U.S. buyout and mezzanine fundraising ($B)