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Private equity’s cash flow woes create fundraising challenges for hedge funds

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Private equity’s challenges in returning capital to clients are increasingly affecting hedge funds, which depend on the same pool of institutional investors including pension plans, foundations and endowments, for their fundraising efforts, according to a report by the Financial Times. 

Hedge funds attempting to secure funds from these institutional investors are encountering difficulties as these institutions report insufficient cash availability. The Financial Times partly attributes this issue to a significant slowdown in distributions from private equity funds. 

Michael Monforth, global head of capital advisory at JPMorgan Chase, said: “The lower rate of distributions from private equity, [private] debt and venture funds is having a knock-on effect, leading some allocators to pause on new investments into illiquid funds and reduce new investments in more liquid hedge funds.” 

According to Bain & Co’s annual private equity report, buyout-backed exits plummeted to $345bn last year, marking their lowest level in a decade, resulting in the private equity industry holding a record backlog of 28,000 companies valued at over $3tn. The slowdown in dealmaking has made it increasingly difficult for private equity firms to return capital to their investors. 

“Private equity distributions have gone down, the IPO market has been very thin, and M&A has been held back,” said Nick Moakes, chief investment officer of the £36.8bn Wellcome Trust. “If you’re not going to get bought and can’t get listed, PE is scratching its head on how to do distributions.” 

Hedge funds and private equity managers often compete for the “alternatives” allocation from institutional investors, which also includes private credit, infrastructure, and real estate assets. The recycling of distributions from existing holdings into new commitments is a critical component of this allocation strategy. 

Sunaina Sinha Haldea, head of private capital advisory at wealth manager Raymond James, said: “For the vast majority of institutions, private equity and hedge funds come out of the alternatives bucket. 

“The lack of distributions out of private markets portfolios is going to impact the ability to make new commitments in other parts of the alternatives portfolio, including hedge funds.” 

The Bain & Co report highlights that assets in the global private capital industry surged to $14.5tn last year, more than triple the $4tn managed a decade earlier. In contrast, hedge fund inflows have been muted over the past decade, with net investor withdrawals occurring in five of the last ten years, according to Hedge Fund Research. Performance, rather than inflows, has driven most of the industry’s growth.   

This capital-constrained environment is also affecting the market for new hedge fund launches. For instance, former Millennium co-chief investment officer Bobby Jain has been forced to scale down fundraising ambitions for his new hedge fund, Jain Global, ahead of its July launch. 

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