Are private markets going super-size?
We’ve seen a concentration of capital among some of the largest private markets firms over the past decade as many have established or acquired a range of strategies to offer investors. Is this set to continue as fundraising pressures bite? And what is the logical endpoint of the scramble for scale?
Fundraising is challenging right now as LPs grapple with the denominator effect, compounded by fewer distributions in a more challenging exit environment. And while this will work through the system as public and private market valuations come closer and exits do start to happen, the landscape may well alter over the coming years as some GPs and LPs start to take advantage of the opportunity to snap up or build new capabilities and some firms start to falter in a more difficult market.
The past few years has seen the number of private markets funds proliferate (there are 18,000 at least, according to the Securities and Exchange Commission), yet an ever-greater proportion of capital has become concentrated in a smaller number of players, a trend accelerated by the downturn in fundraising. In buyouts, for example, the total capital raised dropped 16% in 2022 compared with 2021, according to Bain & Co’s analysis, yet the number of buyout funds raised dropped precipitously – by 43%. The mega-funds (run by experienced managers and targeting more than $5bn) attracted 57% of all capital raised for buyouts, exceeding aggregate targets by 15%.
McKinsey analysis backs this up – it points to a 40% drop in first-time fund launches and the lowest number of funds reaching a close in 2022 since 2013. Further, Bain & Co adds that: “As in any downturn, the scarcity of capital will mean roughly a quarter of funds now in the market won’t raise again.”
Strength in (fewer) numbers?
These trends are leading many in the industry to talk of further increases in scale for the industry’s largest players. And while fund sizes may not increase as much as we’ve seen over recent years, many firms are looking to add further capabilities and strategies to offer their investors. “The strong are getting stronger,” says Julian Salisbury, Chief Investment Officer, Asset and Wealth Management at Goldman Sachs. “LPs are scaling back the number of GPs they commit to and are seeking holistic portfolio advice as opposed to exposure to a single product.” LPs are also looking for the comfort of additional resource that scale can bring in more turbulent times. Capital markets and economic forecasting expertise is one area where larger firms are typically standing out today, according to Joana Rocha Scaff, Managing Director and head of Europe Private Equity at Neuberger Berman. “We see a wide dispersion in the preparedness of portfolios for the changed interest rate environment we see today,” she says. “Some managers in the large space with macro teams have prepared well in advance of monetary policy changes. They have worked to push out maturities and hedged interest rates – among our large cap fund manager relationships we have generally seen them hedge around two-thirds to three-quarters of their portfolio companies’ debt. Some have also managed to negotiate portability clauses for the companies they plan to exit in 2023 and 2024, so that they can sell the businesses with a debt package in place.”
LPs are also looking for the comfort of additional resource that scale can bring in more turbulent times. Capital markets and economic forecasting expertise is one area where larger firms are typically standing out today, according to Joana Rocha Scaff, Managing Director and head of Europe Private Equity at Neuberger Berman.
While one of the most obvious choices for expansion in other industries has been acquisitions, this wasn’t the route for private markets investors in times gone by.
That has changed significantly over recent years, however, as publicly listed firms in particular have sought to boost AUM to satisfy shareholder expectations of fee growth.
EQT, for example, has made a number of acquisitions since going public in 2019, including the largest ever takeover of a private equity firm by another - the €6.8bn deal for Baring Private Equity Asia. Meanwhile, publicly listed asset management firm Franklin Templeton, has been making in-roads into alternative asset strategies through a series of acquisitions – Lexington Partners, Benefit Street Partners, Clarion Partners and K2 Advisors.
This is a natural evolution of the industry and a logical response to current market conditions, say some. “In any industry with too many players and demand pressures, consolidation is a natural and often desirable evolution,” says Hazem Ben-Gacem, Co-Chief Executive Officer at Investcorp. “Private markets are no different and I believe our industry is headed towards some degree of consolidation. There are too many participants competing for the same capital and GPs with a distinctive investment proposition will have the opportunity to come out of this in an even stronger position.”
M&A enters the fray
Institutions are bulking up
Yet it’s not just GPs that are undergoing a phase of consolidation. We are also seeing some LPs conclude that scale is important to them, too. “We are seeing a shift from the investor side,” says Georg Wunderlin, Global Head of Private Assets, Schroders Capital. “Defined benefits schemes are becoming more constrained as capital increasingly flows towards defined contribution schemes and wealth management. Insurance companies are also facing constraints, leading them to acquire pension funds to expand their balance sheets.”
This, combined with the consolidation in the industry more generally, is resulting in some large-scale shifts, he adds. “Private markets are industrialising rapidly,” says Wunderlin. “Technology will drive the next phase of development, and in the next five to seven years, we will witness a convergence between the public and private markets to the extent that it will become difficult to distinguish between what is public and what is private as investments are set up on distributed ledgers.”
Overall, it seems that, in a perhaps just few years’ time, private markets could look very different indeed.
One of the biggest hurdles that previously held back private markets from striking M&A deals with competitors and firms in complementary markets was managing firm culture. This remains an issue but is perhaps less of a constraint today as firms have become more institutionalised and often less dependent on one or a couple of star investors.
Since 2015, Schroders Capital has used M&A to help building out its private markets capability – it has acquired firms such as BlueOrchard and Greencoat over recent years. For the firm, creating a cultural fit for both the acquired businesses and the larger Schroders teams was a crucial part of the process. “Our aim was to add value to the acquired firms while respecting the independent investment culture of their teams,” explains Schroders’ Wunderlin. “We have achieved this through subsidiarity – we support their operations with fundraising, sustainability and impact expertise and solutions, while allowing the teams to remain independent in their successful investment processes. We also ensured that creating Schroders Capital was a project for all of us to create a super-partnership. Instead of enforcing rigid processes, we created a network organisation that used talent from within the business when and where needed.”
Franklin Templeton has also been on the private markets acquisition trail for the past few years. Jenny Johnson, President and CEO, explains her firm’s approach to managing cultural issues in mergers. “In our experience, culture is of critical importance to successful acquisitions and often isn’t given as much weight as price and strategy when deals are first brought to us. We will not proceed if we feel the target’s culture is a mismatch with ours,” she says. “What we look for in culture are the three Cs – Client, Collaboration and Continuous improvement. The client always needs to be first and that can mean stepping back on earnings if it is the right thing to do for the client. Collaboration – is there an environment where teams work well together and what incentives are in place to make this happen? And finally, continuous improvement – meaning a focus on innovation, which is especially relevant in today’s market and with rapid technology advancements, to gain and maintain an edge.”
“What we look for in culture are the three Cs – Client, Collaboration and Continuous improvement. The client always needs to be first and that can mean stepping back on earnings if it is the right thing to do for the client. Collaboration – is there an environment where teams work well together and what incentives are in place to make this happen?
