Published by Asia Asset Management – 11th Sep 2017
After weeks of shrill Cassandra warnings of the risks for institutions ploughing money into private equity (PE) funds at a period of peak valuations and peak dry powder, perhaps it’s now time to take a slightly more optimistic view of the case for dry powder. In other words, why PE firms may be doing the wise thing in sitting on their dough instead of deploying it.
After all, it’s a common sense proposition that you don’t buy into a seller’s market at its peak. So perhaps general partners (GPs) are to be applauded for letting dry powder pile up to around the US$1 trillion mark before priming their weapons and actually pulling the trigger – or applying the slow match, if we’re persisting in the powder metaphor – on deals.
Bloomberg kindly provided a detailed breakdown of this thesis in a recent story, complete with links to various sources, including Preqin’s latest estimates of $963 billion of global dry powder in July 2017, which is obviously going to breach $1 trillion soon. What’s good about all that uninvested capital? “It’s not being dumped into bad deals to make investments for the sake of investing,” according to Bloomberg.
The most telling new information in the article, though, is about the holding arrangements for that dry powder. Historically, it’s kept in “cash and cash equivalents such as money market funds.” But “increasingly, investors are parking money earmarked for private equity into exchange-traded funds [ETFs] in an effort to eke out extra returns while they wait. The average time it takes for new commitments to start being invested has been pushed out to as long as three years, up from one year previously, according to State Street,” the article says.
Bloomberg’s separate analysis of this quotes State Street’s Chirag Patel to the effect that institutions simply “are buying index exposure”.
Yes, this tactic keeps the money both earning and available for potential capital calls from PE funds. But it’s also developing into an alternative form of lock-up, where the institution passes up other investment opportunities to keep that ETF flexibility. For up to three years, which is already longer than the entire raising/investment/realisation cycles for some past PE commitments.
Sure, the ultimate return from a big buyout deal might be better than what other asset classes can offer – but the actual, current returns from those ETFs, and the commensurate opportunity cost, should be weighed against that.
Institutions might not need much help to glean the obvious point. If your money is going to sit in ETFs for up to three years anyway, why aren’t you just keeping it there? If you’re so short-termist that you switch into PE the moment equities look overpriced, why are you taking a route that simply leads to more exposure to the public markets by the back door?
Perhaps the case for more dry powder isn’t looking so hot after all.
