Investors Fleeing Credit Meltdown Selling Stakes in Buyout Funds
Until very recently public and private employee pension funds were loading up on private equity in a relentless drive for above-market returns.
Two of the biggest US public employee pension funds - California's CalPERS and the Washington State Investment Board - last year increased their overall allocation to private equity to a record 10 and 25%, respectively. CalPERS went a step further and bought direct stakes in Apollo Management, Carlyle, and Silver Lake Group (see see Growing Pension Fund Stakes Feed PE Search for 'Permanent Money on this site. Frozen out of the top league of established buyout funds, hundreds of pension funds worldwide arriving late on the scene competed frantically to invest in newer, smaller funds, which in turn fed the competition to close more and bigger buyout deals, at any price, as long as credit was cheap and regulation largely non-existent.
So strong was the pressure to invest - even as LBO defaults soared and the meltdown in the financial markets deepened - that the largest buyout funds had little difficulty in meeting their fundraising targets well into the financial meltdown, even closing out some funds early as recently as six months ago. With money pouring in and megabuyouts no longer on the investment map, pe funds were estimated to be sitting on some USD 450 billion in uninvested capital (up from USD 300 billion at the start of 2007) - on which pension funds were paying high "maintenance" fees.
A Financial Times article of November 23 now reports that some anxious investors are dumping these investments at a huge loss. But unlike hedge funds, which are less illiquid, private equity funds don't allow for easy exit. As a consequence, investors are forced to sell their shares in a growing secondary market. According to the article, "Investors in buy-out funds are so concerned private equity returns will slump in the years ahead that they are selling their commitments for as little as 30 per cent of their original value. Eighteen months ago, if such stakes were available at all, they generally traded at a premium."
"The sell-out from private equity funds," the article continues, " is gathering speed as pension funds, endowments and family offices realise these funds are likely to fall far short of original target returns. They are already reeling from losses in the stock market and on hedge fund investments.
"The collapse in valuations reflects growing concerns that many private equity-owned companies will implode as the economic contraction intensifies. Some of the largest deals, struck at the height of the private equity boom that ended in the spring of 2007, now look to be disastrous for the equity holders.
"Monte Brem, chief executive of StepStone, which acts on behalf of such investors, says he thinks it may make more sense to buy funds at a sharp discount in the secondary market rather than paying full price for stakes in new funds. Mr Brem is now considering buying stakes in the secondary market for his clients."
A November 30 Financial Times update states "Investors are likely to sell about $140bn in private equity investments - more than 10 percent of the total - in the next 18 months", with some analysts predicting even greater flight.
How many pension funds are now liquidating their investments at a huge loss after years of chasing alpha returns at the expense of jobs and the stability of the financial system? Unions should be asking their pension fund trustees.