PitchBook’s research has highlighted a flood of fresh capital into the PE & VC space over the past few years, a trend that has since only intensified.
This summer has been record setting with the largest-ever fund close (SoftBank Vision Fund, $93 billion), the largest-ever US PE fund (Apollo Investment Fund IX, $24.7 billion), the largest-ever European PE fund (CVC Capital Partners VII, €16 billion), the largest-ever Asia-focused fund (KKR Asian Fund III, $9.3 billion), and the largest-ever US-based tech PE fund (Silver Lake Partners V, $15 billion). We’ve also seen the largest-ever VC fund (NEA 16, $3.3 billion).
Other record raises are in progress, with Blackstone halfway through the largest-ever infrastructure fund ($40 billion targeted). Overall, our data shows 2017’s PE fundraising across North America and Europe is tracking for a 24% increase over 2016’s impressive haul of $294 billion. On the VC side, this year is set to be the fourth consecutive year with more than $40 billion in commitments.
Amid the superlatives, a question is begged: Why?
PE dry powder is already plentiful (at about $740 billion for our tracked PE funds, up from a low of $611.5 billion in 2010)—same for VC ($120 billion, up from $92.7 billion in 2013). And PE & VC TVPI return multiples have been in cyclical decline while M&A deal valuations have swelled. Risk has only been rising as exit activity declines along with exit size, a topic covered in depth in our 2017 PE & VC Exits report. And hold times are lengthening, with time from first VC round to IPO increasing to 8.3 years in 2016 vs. nearer to five years in 2011.
A combination of higher risk, a narrower exit window, longer hold times, and lower overall return multiples isn’t normally a recipe for intense investor interest—unless it’s made appetizing by sake of comparison.
It’s important to remember private markets don’t operate in isolation but as an alternative to traditional public market asset classes. And the situation there suggests that a “reach for yield” dynamic—typical of late-business-cycle investor behavior—is in play.
To be sure, we’re operating within the confines of what has traditionally defined the latter stages of a business cycle. The US Federal Reserve is well within its policy tightening cycle. The US unemployment rate has fallen to just 4.3%, lowest since 2001. Corporate profit growth has leveled off.
And the investment yields on other asset classes simply aren’t attractive to many accredited and institutional investors. For pensions, the situation is made worse by a deepening asset-to-liability mismatch, as illustrated by the chart below from Milliman’s Corporate Pension Funding Study. The motivation to close this gap via higher portfolio returns could hardly be stronger since higher returns are necessary to avoid painful benefit cuts.
Treasury yields are falling again, corporate bond spreads are extremely tight, equity market valuations have rarely been higher (suggestive of lower future returns), and according to research from both Barclays Capital and Goldman Sachs, hedge fund returns have been poor since 2009. Last year saw the first net outflows from hedge funds since the recession, per J.P. Morgan. Out of desperation, hedge funds have recently begun piling into a small list of big-tech stocks with familiar names—Apple, Amazon, and the like—according to Goldman Sachs research, increasing their exposure to a possible equity market decline.
None of these dynamics show any sign of slowing, suggestive of a strong tailwind for the private fund industry and startup entrepreneurs, as PE & VC opportunities are seen as a refuge in a low-return world.
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