As markets recover from the pandemic downturn, a perhaps unexpected result has emerged in the private equity world: certain funds, generally those raised by established managers with strong track records, have been breaching their hard-caps.
“Fundraising is very, very, very busy right now,” says Brian Gildea, head of investments for private markets investment firm Hamilton Lane, with heavy emphasis but perhaps a bit of understatement.
Some examples: Peak Rock Capital put its third vehicle on the market at the start of the year, targeting $1.3 billion. Within weeks, that target had increased to $1.8 billion, and sources told Buyouts in February that increase was due to LP demand. The fund ended up closing on $2 billion in April.
JMI Equity, a veteran software investor, hit the market with its 10th fund in late 2020, targeting $1.3 billion, according to a Form D fundraising document. But in February, the firm filed a new Form D revealing it had already passed that target with $1.5 billion raised, only to set a new one at $1.7 billion. The fund closed at that amount in February.
Not to be outdone, Hellman & Friedman began raising its 10th vehicle early in the year with a $20 billion target. The fund barely hit the market before essentially oversubscribing due to massive LP interest, sources told Buyouts. The firm eventually hard-capped the fund at $22 billion. (None of the firms opted to comment for this story.)
Activity like this speaks to heavy demand from limited partners for private equity as they emerge from the pandemic market disruption that marred much of 2020. From the beginning, 2021’s private equity fundraising environment has felt fast, robust and fiercely competitive for firms and investors alike.
The numbers speak for themselves. In the first quarter of 2021, 175 funds raised $122 billion, up 5 percent from a year earlier, according to Buyouts data. This was the busiest fundraising quarter on record. The average size of the vehicles, $701 million, was also a record.
“From an LP’s perspective, when you sum it all together, it’s just as active a time period as I’ve seen,” says Brian Rodde, a managing partner at Makena Capital Management.
LPs are racing to get their capital into high-performing managers while they can, eager to not miss out on what is widely seen as a strong investment landscape moving forward. But to understand how this fear of missing out swept over the LP community, you need to look back at an earlier “end of the world.”
‘A tale of two halves’
LPs learned lessons after the global financial crisis in 2008, when many institutional investors paused their private equity activity out of fear of a liquidity squeeze. By skipping private equity funds that invested into the market recovery, those LPs missed out on some strong vintage years.
“Institutional investors have largely figured out by virtue of their 2008 experiences that you can’t just hit pause,” says Ivan Zinn, founding partner and chief investment officer of private debt firm Atalaya Capital Management, which raised a $1 billion fund during the first quarter.
“And you can’t hit pause for a long period of time, because that means you miss out on vintages, you have lumpy deployment or in some cases you get massively outside of what your targeted parameters are.”
This time, as markets recovered from the pandemic, LPs continued committing to private equity.
“People came to the realization that they’re not going back to the office, that we were just not returning to normal any time soon,” says Peter Martenson, a partner at placement agent Eaton Partners, a division of Stifel. “So if they need to invest as they need to invest as LPs, they had better get to business.”
By the fourth quarter, activity in the private equity markets was remarkably robust, creating what Gildea calls a “tale of two halves.”
“We came out of the back half of 2020 with very, very strong fundraising activity and momentum,” he says. “We’ve seen no signs of that abating in 2021.”
A dynamic, maturing market
As fundraising picked up late last year, so did dealflow, and that led to a lot of money finding its way into the pockets of LPs via distributions, leaving them with plenty of cash to put towards new funds. That has helped drive the fundraising machine.
“I think the distributions were certainly a big part of that, because it’s not just paper money, it’s actual cash on hand,” says Jill Shaw, managing director at investment firm Cambridge Associates. “I think that’s what’s really driving it.”
One LP, Florida’s State Board of Administration, received $600 million in private equity distributions in December 2020 alone.
“The PE market closed out 2020 with a bang,” said Florida senior investment officer John Bradley to the system’s board at an April meeting. “Across almost all measures of activity – whether it be deal value, deal volume, IPO value, IPO volume – we saw close to record quarter and annual activity.”
That robust investment environment also has allowed firms to deploy their previous funds and return to the market quicker than expected. Shaw notes firms she had expected to see come to the fundraising market later this year or early next year moving up their fundraises.
“It does feel like many managers have deployed their funds perhaps a little bit faster than was anticipated,” says Todd Silverman, a managing principal with consultant Meketa Investment Group. “It feels like a continuation of the high velocity of investment deployment in really a lot of the same ways that we’ve seen pre-covid.”
Gildea also pointed to the increased creativity being shown by larger managers. According to Cobalt/Hamilton Lane data, more than 50 percent of the capital raised by the 10 largest PE firms in 2019 was raised outside their flagships in new strategies like credit, infrastructure and growth equity.
That creativity also stretches to the growing interest among GPs and LPs for more flexibility in ownership structures through GP-led secondaries, continuation vehicles and single-asset or multi-asset recapitalizations.
“They’re recognizing that they have these LPs, so why not two-fer them since they can’t meet with new managers?” says Martenson. “Why not offer them a new product and capture them in a new strategy, too?”
Best of the best
The focus on re-ups also speaks to another deciding factor in which firms have success and which do not. Fundamentally, it comes down to performance. Peak Rock, JMI Equity and Hellman & Friedman all have solid track records, which has made it easier for them to attract LP capital.
Sector specialization also played a role in successful fundraising. For instance, JMI Equity invests solely in software. The technology sector overall found success during the health crisis as jobs and education went remote, using software to keep running their operations.
Tech’s share of total deal volume last year climbed to 22.7 percent from 18.5 percent, according to research from McKinsey & Co. Tech-focused buyouts funds generally pooled 6.4 percentage points higher than those of non-tech funds over the last decade, McKinsey found.
Healthcare also found favor with investors last year. Oak HC/FT’s fourth fund closed on $1.4 billion in February, well over its $1.1 billion target. And first-timer Patient Square Capital, formed by ex-KKR healthcare chief Jim Momtazee, is on its way to $3 billion for its debut, which would make it among the largest-ever first-time funds.
Many emerging managers, and especially first-time funds, had a tough time finding capital last year, a function of LPs sticking with their most trusted relationships in the uncertain environment.
Still, Cambridge’s Shaw says emerging managers are having success raising capital for tech and healthcare investments. Among the newer funds in these sectors tracked by Buyouts this year include Denali Growth Partners, which raised just over $200 million for its inaugural vehicle, and independent sponsor Hughes & Company, which had raised most of its $100 million first vehicle as of late March.
Tom Durkin, vice-president at placement agent Monument Group, expects that to continue after a re-up heavy 2020, especially as vaccination efforts speed up the ability for GPs to meet with LPs in-person as they try to form new relationships.
“First-time funds deliver outsized returns more frequently, deliver poor returns less frequently, and return capital more quickly,” he says. “There’s ample interest on the part of LPs for newer upstarts.”
Demand over supply
With so much capital being raised, the natural question is whether there will be enough opportunities to go around. And whether GPs will be forced to chase lower quality as they deploy capital into an overheated environment. Sources say this is an almost constant question in the industry.
“I’ve been in the industry for 25 years now, and every single year everyone’s talked about how hard it is to put money to work, and how competitive it is,” says Hamilton Lane’s Gildea. “We haven’t seen anything that tells us that the current environment isn’t favorable for the private markets.”
“Some years are going to be lighter than others, and some years are going to be heavier. You sort of have to flex from one year to the next, and make sure you’re just trying to take advantage of the best opportunities that arrive”
Makena’s Rodde says managers have become increasingly sensitive to the cadence of institutional fundraising. It can be helpful to GPs to raise capital near the beginning of the year, when LPs are at the start of their yearly budgets. Considering how robust fundraising has been in the front half of 2021, some firms planning a raise later in the year may do a first close in Q4 2021 and then another one in early 2022 so LPs can invest from their budgets for that year.One LP concern is how the large amount of funds that hastened their fundraising processes will affect the market later this year.
Shaw says that while she is about halfway through the budgets for many of her clients as of late April, she is open to committing more should good opportunities present themselves.
“Some years are going to be lighter than others, and some years are going to be heavier,” she says. “You sort of have to flex from one year to the next, and make sure you’re just trying to take advantage of the best opportunities that arrive.”
Concentration of LP commitments: more money, fewer GPs?
As investors place fresh bets in a post-covid fundraising market, the main beneficiaries could be a small fraction of private equity’s GP community, writes Kirk Falconer.
A body of evidence suggests more capital flowing into private markets is going to fewer funds. The trend, often referred to as “consolidation,” is the result of limited partners allocating more of their money to select general partners – mostly big, brand-name firms with long track records.
Consolidation in global fundraising has inched higher in recent years, Buyouts data show. Between 2010 and 2020, the share of commitments captured by the top 20 vehicles rose to 37 percent, from 25 percent. For the top 10, it went to 25 percent, from 16 percent.
Among private equity giants, this is welcome news. In February, Carlyle CEO Kewsong Lee said his firm’s plan to secure at least $130 billion by 2024 would benefit from the biggest LPs “wanting to consolidate their relationships and concentrate commitments with fewer GPs.”
Choice plus convenience
Consolidation is mostly about LPs “demanding more choice and customization,” Brian Gildea, head of investments at Hamilton Lane, tells Buyouts. For many investors, the large managers with the platforms and resources to scale multiple opportunities are the ones “who can do this.”
To meet LP demand, leading buyout firms are “expanding into other strategies, such as credit, infrastructure and real estate, and establishing new fund families,” Gildea says. Citing Cobalt-Hamilton Lane data, he notes more than 50 percent of fundraising by the top 10 GPs now involves non-flagship strategies.
Another important factor, Gildea says, is the fact investors can handle “only so many GP relationships.” Especially in today’s crowded fundraising market, with its ever-growing pipeline of new offerings, “LP convenience is a big driver.”
Not every LP, however, will see concentrated commitments and fund portfolios as the right solution, Gildea says. “If you’re good at picking managers, you probably won’t consolidate.”
Kelly DePonte, a managing director at Probitas Partners, agrees. He tells Buyouts that many investors – including small LPs like endowments and foundations, family offices and high-net-worth individuals – are not fans of the largest GPs, who they regard as “asset-gatherers” and “fee-takers.”
“A lot of LPs see large managers as overseers of funds instead of as investors,” DePonte says. “Not everything they touch turns to gold.”
Because of this, DePonte says, small investors often target their commitments to small managers, who they believe possess “a better ability to generate high returns.”
It is possible that the fundraising market is on a path toward bifurcation, with large and small LPs showing a predilection for large and small GPs, respectively, DePonte says. In this scenario, he notes it might be challenging to sit in the middle, “squeezed by LP preferences.”
A similar idea is expressed by Gildea. If, as he expects, LPs continue to allocate more capital to large multi-strategy managers, there may be some “thinning out in the middle.” The toughest spot to be in could be “single-strategy firms that are not performing.”
UPDATE: this story has been updated to reflect that JMI Equity’s tenth fund closed in February, not in March. It has also been updated to refer to Hamilton Lane as a private markets investment firm, not a consultant.