I recently accused limited partners of cognitive dissonance; refusing to invest (much) this year despite acknowledging that the best returns are borne of recessions.
But perhaps I was too harsh. Too hasty. Perhaps LPs are sitting on their hands because they recognize that this post-recession is different.
Private equity firms typically generate out-sized returns from post-recessionary markets because there is an abundance of bargains, which can be easily exploited. Buy low, sell high.
This year, however, valuations rebounded much faster and stronger than anyone expected. So much so, in fact, that some PE pros are concerned that they’re trapped inside of a mini-bubble.
How come? The primary culprit is private equity overhang, which Cambridge Associates estimates at around $425 billion. Many firms raised big funds in 2006 and 2007, were credit crunched out of investing over the next two years and now are staring down the end of their investment cycles with a pocketful of cash.
Rather than lose it, these firms are trying to use it.
“We’re between a rock and a hard place,” a PE pro told me yesterday. “Either we keep not investing — which means we ultimately hand back capital — or we stay, fight and pay a bit too much. Even some of the deals that began as proprietary have become competitive.”
Exacerbating the situation is the fact that corporate America is sitting on $1.84 trillion in cash, up a record 26% from last year. This means that if financial sponsors opt not to compete for a particular deal, there’s a good chance that strategics will.
“LPs shouldn’t ever try to time the market, since there can be such a long lag from fund commitment to when the money actually gets invested,” says an LP. “But, they obviously do try to time it and, for those people, these ridiculous valuations are a good reason to wait.”