drypowder

Does Private Equity Have a Dry Powder Problem?

by

March 9, 2017

Private equity is constantly looking to break records. Last December, the record-breaking figure on everybody’s lips was $820 billion. According to Preqin, this was the amount of dry powder private equity firms had available for investments. Does it show the industry to have a problem?

 

Deals aren’t getting any cheaper

 

Although private equity funds stood on top of the money, they haven’t found deal-making to get much easier. Asset prices have continued to increase – slowly but surely – and fears of another global recession are still haunting investors and lenders.

 

Bain & Company published a report into the industry and warned that deals aren’t getting any cheaper or easier to close. Chief Investment Officer quoted Hugh MacArthur, head of global private equity with the Boston consulting firm, who said, “While caution about interest rates remains, there is a general expectation that debt will remain affordable”. This will continue to keep deal prices high.

 

Furthermore, some investors ended up in situations where they fell short of their private equity allocation. The Chief Investment Officer article pointed out to the example of the Washington State Investment Board. The pension fund’s private equity allocation dropped in 2016 to 21%, when in 2012 it stood at 26%. There has been a dip in the number of companies private equity firms are able to flip over in less than three years. In 2008, 48% of private equity buyouts were these types of companies, while last year the figure stood at 18%.

 

Overall, funds from 2006, and in some instances even earlier, are still holding over $210 billion in unrealised assets.

 

Investors want more

 

Despite the amount of dry powder, big private equity companies continue to fundraise and with success. Investors are not just throwing their money into the wind either. The data showcases how private equity portfolios continue to generate a higher annual return than other assets such as equities.

 

Furthermore, while the dry powder levels might be hitting new records, funds and firms continue to spend capital proportionately. In fact, Preqin’s research shows this capital overhang continues to be close to the levels in 2001.

 

Private equity firms have started deploying money a bit quicker, yet few firms would opt for rash spending in order to boost returns. Bloomberg post on dry powder actually reminds of studies that point to the opposite. “Returns are more closely tied to average purchase multiples – that is, in years when purchase price multiples were the lowest…returns were better- than-average,” the post concludes.

 

Last year was influenced by global events, such as Brexit and the US election. Therefore, deal-making might well be increasing this year, especially if the Trump Administration follows through with its policy plans that might boost the industry. Dry powder is unlikely to deter investors at this point – interest in private equity is strong, largely due to its strong performance. Nonetheless, firms need to be able to find the right deals from a tiny pool and be able to put the money to work – investors will continue to look for value.

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