Private equity funds are said to be sitting on $3.2 trillion in unsold assets. The sector, which has underperformed the S&P 500 over one, three, and five years, is going through a turbulent period. Distributions to investors have fallen to their lowest level in ten years, while asset holding periods are lengthening. Exits rebounded in 2024, but doubts about the terms of these disposals are emerging. This analysis is based on figures from the latest reports by McKinsey and Bain & Company on the subject.
In 2024, distributions to investors accounted for only 10% of net asset value, compared with an average of 30% between 2014 and 2017. This decline is prompting investors (LPs) to abandon less generous funds in favor of those capable of returning capital. As a result, some managers (GPs) are accelerating asset sales and seeking liquidity.
Global distribution as a percentage of net portfolio value (Source: Bain & Company)
Lennart Blecher, Managing Partner and President of EQT Real Assets, summed up the mood in the sector last year: "The mantra for 2024 is 'exits, exits, exits'. We believed that returning capital to our clients while others were unable to do so would give us a competitive advantage."
A record stock of unsold assets
62% of portfolio companies have been held for more than four years, compared with 55% in 2023. The exit backlog, i.e. the stock of assets ripe for resale, is at its highest since 2005. However, despite a doubling of assets under management since 2019, the pace of exits remains unchanged. Bain & Co. say that managers and investors believe that the main challenge to generating returns over the next 12 months is the exit environment.
A fragile recovery in outflows in 2024
After two years slowed by rising interest rates, exits will pick up again in 2024. The volume of transactions increased by 22%, with their overall value rising by 34%. The driving force behind this recovery is sales of funds known as "sponsor-to-sponsor" funds, which are up 26% compared to the average for the last five years. This is a sign that some managers remain buyers, while companies and stockmarkets are more cautious.
Value of exits of companies financed by buyouts worldwide, by channel (Source: Bain & Company)
Sales to companies fell by 27% compared with their five-year average. IPOs also declined sharply, falling by 46% over the same period. This channel, considered a last resort for the largest assets, accounts for only 5% of exits in terms of number but 22% of disposals exceeding $500m.
The rise of alternative liquidity strategies
Unable to find buyers, managers are increasingly turning to workarounds. Partial disposals are skyrocketing, accounting for 65% of liquidity events for funds created in 2019, compared with 37% for those created in 2014. Investors are not keen on this option, but it offers valuable flexibility for lightening portfolios.
Three tools are seeing significant growth:
- Continuity funds: an asset is transferred to a new fund, allowing former shareholders to exit and new ones to enter. This is a way of generating liquidity for some without selling the company.
- Asset-backed loans: funds borrow against the value of their portfolio, generating immediate liquidity.
- Dividend recap: a loan is taken out solely to pay an exceptional dividend.
In its report, Bain explains that: "These financial tools are not a substitute for exits. However, they have undoubtedly helped improve cash flows in 2024."
These are all signs that the sector is struggling to return money to shareholders.
Reports show that there is no particular panic regarding the 'public vs private' allocation of investors. The target allocation for private equity in the portfolio has increased from 6.3% in 2020 to 8.3% in 2024. However, consulting firms warn that investments are becoming increasingly difficult to raise, especially for smaller funds.
In short, the industry still has investor confidence in its ability to generate returns. However, a disruption in disposals in the sector could disrupt the natural rotation of capital.
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