They typically receive more than they give to Blackstone and others, but not in a prolonged market downturn
Investors in buyout funds haven’t had to worry about calls for cash for a while. When Blackstone and others asked for fresh capital, they could find it in a steady stream of profits from previous vintages. That won’t work in a prolonged market downturn.
The patrons of private equity, like pension funds, commit to putting up money when a fund is launched, but only give it up when dealmakers need it to buy a company. Meeting those capital commitments is often easy, as buyout barons tend to spread more profit from previous funds than they need for new bets.
US and European managers doled out $2.7 trillion between 2011 and 2021, according to Preqin, and requested $2 trillion. Distributions outstripped requests almost every year, meaning investors could simply recycle their profits into new funds.
But those figures may become unbalanced if the world enters a recession. Buyout barons are understandably reluctant to sell companies at the trough of the cycle, which means deals may decline. They are also willing to buy at the lowest times, knowing that crisis-era funds tend to outperform. The wave of operations has not yet started, because it has been difficult to obtain financing for the debt. But that can change. Thoma Bravo, for example, is stalking the €4.1bn British cybersecurity group Darktrace.
The result is that, soon, signatures of private equity like Carlyle and KKR could ask for much more money than they give. In the last big slump, in 2008-10, capital calls averaged more than distributions by $43 billion a year, equal to 5% of venture capital firms’ total assets under management, according to Preqin. Now, 5% of managed assets would imply an annual net capital demand of 115,000 million.
Investors are bracing for the worst, having sold a record $33 billion in fund shares in the first half, according to the FT, in part to raise cash for capital calls. It’s a painful option, as secondary sales often take place below face value. The California Public Employees Retirement System (Calpers) recently sold $6 billion worth of assets, according to Bloomberg, with discounts ranging from single-digit percentages to 20%. Other options, such as setting aside idle cash or buying pay-as-you-go coverage, also reduce performance.
The internal rates of return announced by the funds, which often exceed 20%, do not reflect the impact of these periodic liquidity crises. Investors seem to have forgotten this lesson over the past decade, when buyout funds’ assets under management doubled to $2.4 trillion, according to Preqin. The imminent capital crisis, much greater than that of 2008, should record it in his memories.