Market conditions don't look about to tarnish the lustre of PE

By Paul Mackintosh - 26/05/14

Global private equity is still suffering from a hangover – or overhang. At least according to Cambridge Associates, whose latest research report, The Global Overhang (According to Goldilocks): Too Much, Too Little, or Just Right?, has concluded that the private equity industry, as at end December 2013, is groaning under “a global overhang of US$909 billion – $168 billion more than the predicted amount of $741 billion”.

Cambridge Associates pins the blame on certain investment styles, with “US private equity, European private equity and global real estate together accounting for $655 billion, or 72% of total overhang”, but the first two of these at least are hardly very significant, since the US and Europe together have the most developed private equity industries and biggest fund pools worldwide. More significantly, though, as well as “23% higher than historical call patterns predicted”, the overhang is also reducing more slowly than in the past.

Cambridge also points to something that it calls the “shadow overhang” – “intent to invest in private equity outside of a traditional fund structure, which would encompass institutions participating in co-invest opportunities or pursuing direct investments via their own teams or via independent sponsors. The shadow overhang could easily match the official overhang estimate due to the sizable institutions that state this intent to invest”.

In other words, there could be as big a pool of excess capital sitting on the sidelines waiting to invest, in the hands of SWFs and major pension fund direct investors. This could be especially troubling for the industry because it’s so much less predictable. SWFs and pension funds are by definition outside the usual fundraising cycles. Even when so many of them also invest in private equity as limited partners (LPs), and may be not only contributing to the overhang through these investments, but actually co-investing alongside the funds they have swollen, they can represent a challenge in the deal space and an impediment to reducing the overhang. After all, if a major institution taking a direct share of a big deal reduces the amount that an independent private equity firm puts into a deal, that amount stays in the overhang as uninvested fund capital.

Market conditions don't look about to tarnish the lustre of private equity, and rein in the overhang, any time soon, though. Andrea Auerbach, MD and global head of private investment research at Cambridge and co-author of the report points to “record-breaking distributions to LPs underpinning rising commitments, cresting acquisition multiples, easily available credit, and robust capital markets”. Hardly an environment likely to induce LPs to sit on their hands.