By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We have a tendency in our industry to overwhelm good ideas with much too much money. Asset flows can be evil as they drive valuations up as too much money pursues to few good ideas. The “winner” in the bidding competition frequently (eventually) becomes the loser in the long run. I recently wrote about this phenomenon as it related to private credit. Well, we have a similar, if not more egregious example as it pertains to private equity. With more than $3.2 trillion tied up in aging, closely held companies at the end of 2023, according to Preqin data. 

I recently read a refreshingly honest post on LinkedIn.com about the current state of private equity. The comments referred to a discussion given by a “leading” voice within the industry who mentioned that the “types of PE returns it (our industry) enjoyed for many years, you know, up to 2022, you’re not going to see that until the pig moves through the python. And that is just the reality of where we are.” That is quite the image. It speaks to my point about too much money chasing too few good ideas. Pension America has pursued a return objective in lieu of one that stresses the securing of the pension promise. Striving for return has forced most participants to load up on gimmicky alternatives, including real estate, private credit, private equity and worst of all, hedge funds.

For the early adopters, returns above those produced by the public markets were achievable, but again, once someone has a decent idea we tend to jump on that bandwagon until the horse can’t pull the cart any longer. What happens next is usually not pretty. This leading voice also mentioned that “fewer realizations and lower returns” were on the horizon until the proverbial pig was digested. Unfortunately, PE firms are holding onto these aging companies and they will need to be refinanced at much higher interest rates which will further reduce expected returns.

In other news, Heather Gillers, WSJ, reported that the honeymoon may be over between pension America and private equity managers. The promise of high returns may not be realized after all. According to Ms. Gillers, payouts from these expensive offerings have all but dried up. As a result, many pension funds are unloading their investments at significant discounts through secondary markets. According to this article, large public pension systems have migrated roughly 14% of the plan’s AUM into PE. What once looked like an investment that could produce a premium return is struggling to match returns of the S&P 500.

Worse, about 50% of the private equity investors have assets tied up in “Zombie funds”, which hadn’t paid out on the expected timeframe. Needing liquidity (should have invested in a cash flow matching strategy), these pension funds are getting an average of about 85% of the value of assets that were assigned just three to six months prior. According to Jefferies Financial Group about $60 billion was transacted in secondhand sales by PE investors last year.

Despite the lack of liquidity and the idea that too much money has been chasing too few good ideas, the “honest’ assessment by our industry “leading voice” stopped at their doorstep. You see, his firm believes that by 2026 (beginning or end of year???) their alternative assets under management will rocket from $651 billion to $1 trillion. Wow! Now how will that pig pass through the python? Are we to believe that growth of that magnitude will not negatively impact that firm or our industry? I guess that the news to date hasn’t been sufficiently ugly to stop this rampage into PE. I’ve seen this movie before. Spoiler alert – the train barrels forward until it goes over a cliff where the tracks used to be. I’d suggest getting off the next stop.