Filling Up On Allocation

Seen the stock market yet today? Down by nearly 150 points on more Wall Street write-downs (or whatever the Charlotte equivilent is). Obviously bad for the private equity markets, as it lowers exit expectations and makes new leveraged financing even harder to come by.

But there is a much longer-term risk in play for private equity: The fund-raising boom may be coming to an end.

We’ve seen private equity fund-raising break records consistently for the past three years, and 2007 is not expected to be any different. Just in the past few months we’ve seen Bain and Carlyle haul in more than $22 billion combined for new funds, and neither has yet held its final close.

I get asked all the time about what’s driving this boom, and there are a variety of reasons. Strong returns, greater PE visibility, new sources of overseas funding, etc. But the primary reason has been that rising public markets have increased real-dollar allocations. A 5% public pension bucket is simply worth more today than it was three years ago — and many of those buckets have actually been expanded a slat or two in the interim.

But what if the exact opposite now begins to happen. If public market woes reduce overall portfolio values of large institutional investors, then their real-dollar allocations to private equity will shrink. In fact, you might see an “under-exposed” investor suddenly become “over-exposed,” without making additional commitments or changing their allocation targets.

Private markets typically follow public markets, whether that be up or down…