In a great piece in the Wall Street Journal, Andy Kessler argues that for private equity, the glory days are over. It’s not that PE funds are having trouble raising money. With the stock market hovering near recent highs, PE funds – in the words of Apollo Chief Leon Black – are selling everything that’s not nailed down. Dow Jones LP Source reports that PE funds raised $266 billion in 2014 – an increase of 11.7 percent over 2013. But despite this success, all is not well with private equity.
As we pointed out in May 2014, funds launched when the stock market is high and buyout targets carry high sticker prices are unlikely to generate the high returns investors expect: “investors piling into PE funds today in the belief that these investments will return a premium over the stock market that justifies the added risk and illiquidity will face disappointment.”
Indeed, PE funds are sitting on a mountain of ‘dry powder’ – capital that investors have committed but that these funds are unable to deploy for lack of profitable opportunities. In his April 1 Term Sheet column, Fortune’s private equity writer Dan Primack noted private equity’s deal-making difficulties. Global M&A activity was 23 percent higher in the first quarter of 2015 compared with the same quarter last year, and nearly 72% higher than in the same time period in 2013. U.S. M&A had its best first quarter since 2000. But private equity experienced a steep decline in buyout activity: deal volume fell by more than 7 percent while the dollar value of PE-backed buyouts declined by nearly 45 percent.
Primack puts the best face on it, arguing that private equity may be hanging back because “it remembers the low IRRs it generated by paying premiums on already-inflated valuations…” That’s probably true, but it is little comfort to the pension funds and other investors that have piled into private equity in the expectation of high returns.