In the winter edition of its well-regarded Global Private Equity Barometer survey, London-based secondary buyer Coller Capital found that “investors are avoiding areas perceived as more risky: venture capital investments and large buyouts.”
Out of the 107 LPs that participated in the survey, for example, about one third said they planned to reduce their exposure to large North American buyout funds doing deals of $1 billion or more in size, while less than 5 percent said they planned to increase their exposure. By contrast, about a third of investors said they planned to boost their exposure to mid-market North American buyout funds (deal sizes of $200 million to $999 million). Just 10 percent said they planned to reduce their exposure.
Limited partners feel “overexposed” to mega-deals, said Steven Klinsky, managing director, founder and CEO of New Mountain Capital, a buyout shop that is working through a third fund of more than $5.1 billion, speaking at the April PartnerConnect conference hosted by Buyouts in New York City. He added: “I think there’s been a flight to the middle market.” (Despite raising a fund over $5 billion, which puts it in our mega-fund category, New Mountain describes itself as a mid-market shop.)
In fact, ample evidence of a flight to the middle market shows up in the Buyouts fundraising database, which tracks money raised by U.S. sponsors. The flight lasted from roughly 2009 to 2011. In 2007, the height of the last mega-fund craze, about half of the money raised by U.S. buyout firms that year, roughly $147 billion, went into funds of $5 billion or more (see accompanying table). That was right about in line with the money sought: U.S. mega-buyout firms in the market that year had a collective target of $243 billion, or 53 percent of the total amount sought.
Last year marked a near-term nadir for mega-funds, after two weak years. U.S. mega-funds took in less than $12 billion, or 13 percent of the total money raised. The collective target of U.S. mega-funds in the market last year, $80 billion, represented 32 percent of the total sought, suggesting that they were losing their fair share of dollars to small and mid-sized funds.
This year, which has seen a parade of mega-firms file back to market, marks a complete turnaround. Of the estimated $72 billion raised by U.S. buyout sponsors through mid-year, 43 percent has gone to mega-funds. That’s actually ahead of the pace you would expect based just on targets. The collective $124 billion sought by mega-funds represents just 39 percent of the total money sought by U.S. buyout sponsors in the market this year.
So what’s happening? Two years ago, the mega-funds just didn’t have legs, said Karen Rode, a partner at Hewitt Ennisknupp who advises institutional investors on their private equity programs, at last month’s Buyouts Chicago conference. But the returns on prior funds have been good, if not stellar, she said, and mega-funds are simply the only place public pensions and other big institutions can deploy the large slugs of the capital needed to keep their GP stables a manageable size. She also pointed to the advent of separate account programs pioneered by Texas Teachers’ Retirement System and New Jersey Division of Investment in which general partners are able to lock in $1 billion-plus commitments across several products. “This industry is full of creative people,” Rode said.
It’s also full of limited partners backing ostensibly out-of-favor mega-funds.