Private equity firms are awash in cash, with nearly US$1trn of available capital, but the industry is facing internal competition as limited partner (LP) investors seek to play a more active role in buyouts, according to David Rubenstein, co-founder and co-CEO of the Carlyle Group.
The structure and composition of private equity funds will change significantly as LPs that would previously have invested in the funds increasingly branch out into arranging buyouts themselves, Rubenstein said.
Rubenstein was giving his views on the future development of private equity firms, based on his 30-plus year career in the industry, at the SuperInvestor Conference in Amsterdam this week.
“I expect we’ll see longer duration funds become more prevalent, with consequently lower fees for LPs and carried interest for general partners [private equity firms].” Rubenstein said.
Many LPs are looking for longer-term investments with lower return targets, which will ripple through the conventional buyout community, Rubenstein said, adding that more permanent capital will also be sought to match longer investment duration needs.
Several LPs that would have previously invested in private equity funds, including Canadian pension funds PSP Investments and the Canadian Pension Plan Investment Board, have built their own operations to buy assets in recent years and some European firms are also looking at co-investment buyouts.
Rubenstein predicted that sovereign wealth funds will replace US public pension funds as the largest source of capital for buyout firms, and said that retail investors will also play a more significant role going forward.
“Individual retail investors will be the biggest new entry as regulations relax on investing in private equity,” he added.
He also highlighted private debt as a significant growth area and predicted that it could grow to rival private equity. Private debt, which includes direct lending that targets small and medium-sized companies, currently has US$600bn of assets under management, according to Preqin.
While the global private equity industry currently has nearly US$1trn of ‘dry powder’ available to spend, the breakneck development of the shadow banking market means that sponsors now form a smaller part of the investment world, other delegates said.
Rubenstein is expecting public and political opinion, which has been highly critical of private equity’s role in turning around underperforming companies via debt-financed buyouts, to relax as knowledge of how the industry works develops.
“A lot of people still don’t really understand what private equity does,” Rubenstein said.
Private equity firms are gearing up to lobby hard against proposed US tax reforms that could curb the private equity industry’s profitability and make buying and selling companies more difficult.
Rubenstein said that a proposed cap on the tax deductibility of interest payments exceeding 30% of income is unlikely to have a significant impact on private equity firms, as debt forms a smaller proportion of buyouts than in the industry’s early days.
The bill also includes a tightening of the carried interest loophole, which allows private equity managers to have their profits taxed at a lower capital gains rate than income tax rate if they hold a company for more than one year.
“I think we can expect some effect there,” he said.
Photo: David Rubenstein, co-founder and co-CEO of the Carlyle Group, speaks at the Milken Institute Global Conference in Beverly Hills, California, U.S., May 2, 2016. Reuters/Lucy Nicholson