Testing the cycle

There is a reason that private equity folks constantly reassure investors—and reporters—that they don’t time the market.

This philosophy translates to firms claiming to not get swept up in bubbles or to not back off when things go bad. They simply invest steadily, no matter the cycle, looking for strong companies to push through the good and bad times.

Now, there is a bit of marketing spin going on here—when markets are strong, generally the fundraising market also is strong. And when firms raise funds they have to get that capital deployed. So in strong markets, firms are generally going to be deploying capital, even if they have to deploy into expensive environments, like now.

In weaker markets, fundraising may dry up save for the best performers. Deal activity may fall away and firms have to back off making new deals.

Sure, a GP may not be timing markets—on purpose—but just by the nature of cycles, they are investing during strong times and pulling back in weaker moments.

Of course, if the market collapses next year, firms are going to be flush with capital and the ability to deploy in an environment when pricing may come down. It could be a good situation for those willing to invest in a down environment.

Same goes for LPs—they also are not supposed to time markets, and yet they sort of do. They commit in strong times and back off in weaker markets. Some may even pull back in stronger times and become … opportunistic.

That’s something we heard from Marcus Frampton, CIO of the Alaska Permanent Fund, during a recent interview with Bloomberg. Alaska Permanent loves private equity—it plans to ramp up from an allocation of about 13 percent now to around 19 percent in five years.

But it’s doing so cautiously, and picking its opportunities.

“I think that there are some deals getting done in late-stage venture and in mega-cap buyouts that people will regret later,” Frampton said. “We’re a little more involved in smaller-market buyouts on the margin than some of our peers and I think valuations are a little bit lower, and I think the sponsors have a little bit more control of the companies.”

Frampton sees some red flags in the market that could indicate a turn in the bull market. “If you look at credit spreads, valuations on public equities or private equities and then where we are in the cycle, late in a 10 or 11-year expansion, it is concerning,” he said. “I’m not calling for the cycle to turn but there’s certainly a lot of red flags out there, so we want to be ready. At some point the cycle will turn.”