The Financial Times is reporting that private equity (PE) assets under management (AUM) declined 2 percent from 2023 to 2024 – the first time a decline occurred since 2005 when AUM was first tracked. The proximate cause was a $3 trillion backlog of aging and unsold assets, as PE firms struggled to unload companies acquired in the last decade. As a result, PE funds were unable to return cash to investors. Payouts have fallen to about half their historical average. Pension funds, the largest source of funding for PE buyouts, have been squeezed the most. They need to receive these payouts on a regular basis to fund their payments to retirees.

How did the private equity industry get into this bind? The usual excuse is that the initial public offering (IPO) market was frozen and PE firms could not sell their companies to the public via the stock market. But it was not an ice storm, a natural disaster, that froze the IPO market. It is PE firms’ misleading estimates of the value of companies in their portfolios during the stock market crash of 2022 that have caught up with them.

At that time, the share value of public companies declined close to 20 percent. But PE firms maintained that their funds had suffered little to no losses. This was a convenient myth for everyone – PE firms looked good, pension funds did not have to write down the value of their private assets at a time when their public assets were declining, and financial managers responsible for a pension fund or company’s PE investments got their bonuses. But that did not change the fundamentals. The value of PE portfolio companies declined along with the decline in the value of companies that trade on a stock exchange.

Soon it was clear that PE portfolio companies had been falsely overvalued. If they were listed on a stock market, their true value would soon be revealed and the game would be up, as financial markets revalued the other companies in that PE fund’s portfolio. Better not to try to sell portfolio companies than risk a write down of the value of the fund. The prices that sellers wanted for their companies were far above what buyers were willing to pay for them. Hence, a frozen IPO market of the PE firms’ own making.

Now PE firms are stuck with a $3 trillion overhang of aging companies that, under the best of circumstances, will take a long time to unwind. The reluctance of investors, including savvy pension funds, to provide fresh funds for buying out more companies will not go away any time soon.