2013 saw the highest level of annual distributions from private equity investments on record. Preqin explores the reasons for this significant increase in the amount of capital returned to investors and considers the impact this will have on the industry in the year ahead.
Record Levels
The latest data from Preqin’s Performance Analyst product shows that annual private equity distributions reached record levels in 2013; in 2013, a total of $388bn was called and $568bn distributed, compared to $492bn and $381bn in 2012 respectively. Although this is not the first time that distributions have increased significantly year on year or exceeded called-up capital, what is notable is the extent to which distributions have surpassed amounts called. As of December 2013, total annual distributions surpassed capital calls by 46%; only in 2004, 2005 and 2011 have distributions exceeded called capital and in each of these years it was by only 3%, 5% and 7% respectively.
Post-Crisis Knock-On Effect
The private equity industry has grown steadily over the last 10 years with total assets under management (AUM) growing to more than $3.7tn as of December 2013; as a result of this growth, distributions and contributions will naturally increase. When considering distributions as a percentage of private equity assets under management, an increase occurred between December 2012 and December 2013 from 11.6% to 15.3%. Annual distributions as a percentage of AUM have hit higher levels prior to 2013, most notably during the buyout boom era before the 2008 financial crisis. However, investors will be relieved to see distribution levels picking up following the lack of capital returned between 2008 and 2010.
The low distribution levels seen in 2008, 2009 and 2010 were the result of sluggish deal and exit environments which meant that fund managers could not put the capital they had raised pre-crash to work, and at the same time, fund managers were holding onto investments for longer. Private equity-backed portfolio companies that were exited in 2014 YTD had an average holding period of six years, which is indicative of the longer time it has taken fund managers to sell investments that were purchased at peak prices during the buyout boom. It is those funds raised by managers during the boom era that are exiting investments now, resulting in the high levels of annual distributions being seen at the moment.
Exit activity is on the increase, and the fact that distributions have outweighed contributions more recently means investors are likely to have more capital available to commit to new private equity funds in the near future. During the crash, funds were calling up more than they were distributing, and so investors found themselves over-committed and as a result, fundraising slowed to a crawl.
Positive signs for investors and fund managers alike have become increasingly evident since 2010 as market conditions have improved. Buyout and venture capital exit activity has picked up, despite significant dips in 2011 due to the European sovereign debt crisis. 2013 in particular saw notable increases, as healthy public equity and buoyant credit markets helped to facilitate exits and recapitalizations, allowing fund managers to return equity to their investors. The IPO market was especially strong in 2013, with the buyout sector seeing 278 such exits in 2013, compared to 183 in 2012, and substantially above the 175 seen in 2007.
Implications
There is a clear upward trend in both the current and target allocations to private equity for the main institutional investor types, including endowment plans, family offices, foundations, insurance companies, pension funds and superannuation schemes, supporting the growth of the industry as a whole. As of 2014, the mean allocation to the asset class is 10.5% of assets under management, but the average target allocation is 11.4%. This will be encouraging for private equity fund managers as it indicates that investors are looking to ramp up their private equity investments in order to meet their desired level of exposure.
Limited partner commitments to private equity funds are drawn and returned over an extended time period. Predicting cash flow in their portfolios, and consequently the required pace of new commitments, can be challenging for investors that are seeking to maintain or increase their allocation levels while retaining reasonable vintage year diversification, particularly when distribution or capital call-up rates increase significantly. When distribution rates last reached such high levels as a proportion of industry size, 2004-2007, some investors found themselves making rapid new commitments to funds in an attempt to maintain their allocation levels, with fundraising for new funds reaching record-breaking levels in 2007 and 2008. When the financial crisis hit in 2008, some of these investors found themselves significantly over-committed and struggled to meet capital calls as distribution levels dropped significantly and their equity portfolios declined in value.
While fundraising has shown continued improvement over the past few years, we are not seeing investors commit to new funds at the pace we saw some reach in 2007 and 2008. However, there is evidence that a significant proportion of the capital recently distributed to investors will return to the asset class in new commitments. Furthermore, average fund sizes have been increasing over recent years. In 2013, there were 1,132 private equity vehicles that reached a final close, collectively securing $516bn of capital, meaning an average fund size of $456mn. In contrast, in 2007, 1,492 private equity funds held a final close, raising a total of $670bn, equating to an average fund size of $449mn. So far during 2014 (September 2014), 565 funds have closed securing $300bn, with an average fund size of $531mn, demonstrating a continuing upward trend.
Will These Levels Continue?
The majority of Preqin’s data suggests generally positive and upward trends in the private equity market at present. Further to the escalating levels seen in private equity fundraising, statistics from Preqin’s Buyout Deals Analyst product indicate continuing improvement in exit conditions. The deal to exit ratio for private equity-backed buyout deals from 2007 to 2014 YTD has decreased every year from 2008, and we are seeing the lowest figures in 2014 YTD during the period 2007 to present. 2014 YTD has had one exit for every two private equity-backed buyout deals, compared to 3.7 deals in 2008. This gives an indication of the strength of public markets at the moment and the success fund managers are having in finding exit routes for the investments that they held on to when the financial crisis hit.
It is notable that the majority of investments made in each year even as far back as 2006 (55%) and 2007 (65%) are still yet to be realized. Should the favourable conditions of the public equities and credit markets persist exit volume is likely to remain high and in turn distribution levels will also follow suit.
Conclusion
The record distribution levels seen in 2013 were the result of the continued growth of the private equity asset class and the ongoing recovery of the financial markets which has led to more favourable market conditions, allowing fund managers to exit the investments they were forced to sit on when the financial crisis hit. The results of Preqin’s latest investor survey indicate that the majority are currently satisfied with their private equity portfolios and many are looking to increase their allocations, which should mean a significant proportion of the recent record distributions is reinvested. A significant proportion of investments made pre-2008 are still yet to be realized, suggesting that if fund managers can continue to find attractive exit routes then high distribution levels are likely to continue for some time yet.
This is an excerpt from Preqin Private Equity Spotlight – September 2014. To download the full report, click here.
