Following the global financial crisis, the private markets enjoyed a long period of growth, buoyed by low interest rates, high credit availability, steadily rising valuations and strong performance. According to McKinsey, the total assets under management in private markets grew 20% per year from 2017 to 2022, reaching $11.2 trillion, while the number of private markets firms is estimated to have tripled over the last decade.
Today, the industry finds itself at an important inflection point. The macroeconomic picture looks very different with rising interest rates, high inflation and deglobalization contributing to a more challenging fundraising, deal-making, exit/IPO environment. The number of private equity deals in the first half of 2023 fell to its lowest level since 2009, according to the Centre for Private Equity and Management Buyout Research (CMBOR).
In addition, regulators are taking a harder look at the private markets too; the SEC’s sweeping reforms designed to increase transparency and reduce risk in US private markets will take effect November 13, while in the UK, the FCA recently announced it will be undertaking a review of the industry. At the same time, private funds are increasingly looking to tap into new sources of capital, in particular the huge and largely untapped retail market, in the shape of HNW investors and DC pension fund money.
The confluence of these factors promises to change the face of the industry, with one possible result being a wave of consolidation. Indeed, Partners Group’s chief executive David Layton recently suggested the number of private market fund managers may fall to 100 over the next decade. For incumbent managers, snapping up these more specialist managers allows for economies of scale and diversification into new channels, for example new geographic markets, new lines of business such as private credit and secondaries to reach more clients, or more lucrative segments of the market – such as the middle market where deals require less leverage than those involving businesses.
Recent examples of industry consolidation include Bridgepoint’s acquisition of US-based renewables specialist Energy Capital Partners, TPG’s $2.7 billion deal to buy credit and real estate manager Angelo Gordon, and CVC Capital Partners’ acquisition of infrastructure-focused manager DIF Capital Partners.
Many large global multi-asset managers are also looking to gain a foothold in private markets, attracted by the higher fees available and the prospect of offering their investor base greater diversification and an expanded product set. Citywire research found that 20 of the 25 largest asset managers globally have either launched a private markets fund or added distribution capabilities targeting the HNW segment. These managers are also acquiring private equity firms to quickly build out their offerings. For example, Franklin Templeton acquired Lexington Partners in 2021 and Alecentra the following year.
Culture clash
In an industry that has for the most part relied on growing its AuM organically, how will GPs deal with the complexities that arise from applying their tried and tested “buy low, grow fast, sell high” strategy to their peers? According to various surveys, around three-quarters of all post-merger integrations fail to meet their original objectives due to cultural clashes. GPs, however, have experience on their side and should be able to apply the lessons learnt from their portfolio investments across a range of industries. They understand the varying levels of integration complexity and know better than to overlook culture compatibility across the M&A process.
Robbed of choice
According to PitchBook's Q2 2023 Global Private Market Fundraising Report, funds over $1 billion represent nearly 79% of all capital raised. If the pace of private-equity mergers continues to accelerate, LPs will be spared of the problem of being spoilt for choice as they would be in a saturated market. This is a double-edge sword. On one hand, M&A synergies promise increased revenues, enhanced talent and expertise, access to the latest technologies, and operational efficiencies.
On the other, as capital is increasingly consolidated among a smaller group of mega-managers, LPs are likely to see higher fees and less choice. With fewer players in the game, competition will dwindle and so may innovation. This is where regulators will come in. Private equity may eventually see echoes of the consolidation crackdown the tech sector experienced at the hands of antitrust regulators looking to protect innovation.
Size matters
On the face of it, LPs should benefit from having their investments managed by a larger, better equipped GP. But the truth is that many LPs don’t want to concentrate their private markets allocations in the hands of huge asset managers who may be more motivated by management fees than carry – especially if the firm is public and more focused on growing their assets under management and product offering than investment returns.
Many smaller LPs in particular often prefer having a closer relationship with a more moderately sized fund, so that they are a more meaningful investor for that asset manager.
Risks of venturing off-piste
Many GPs that were once single-strategy or niche firms are looking to acquire their way to becoming multi-strategy asset managers – a one-stop shop for LPs. But the difficulties associated with moving into new markets and asset classes must not be underestimated.
For the managers that branch out and have a strong previous track record, their reputation and success in future fundraisings will largely depend on their brand, the strength of which will be determined by a compelling investment thesis and robust USPs. Moving into new and unfamiliar territory risks diluting that brand and possibly tarninishing their reputation.
SuperReturn and BackBay Communications' recent Private Equity Brand Study found that the vast majority of private market professionals say the need for a strong brand has increased notably in the last two years, amid increased competition for deals and for attention. Deal sourcing/CEO awareness is the most commonly identified reason for needing a strong brand, followed by fundraising/LP awareness.
As consolidation ramps up, there remain plenty of focused, niche firms, with deep geographical and/or sector expertise, delivering strong returns that will continue to be sought out by investors. Are these managers that stick to their bread and butter more likely to reap the rewards? The answer, at least in part, lies in how clear they are about their brand and strategy. It has never been more important for GPs – whether niche or multi-strategy – to showcase their differentiators to stay in the game.
With thanks to BackBay Communications for their contribution to this article.