The recent rally has a lot to do with markets realising that the US administration does not have a very high tolerance for market and economic pressure and will be quick to back off when tariffs cause pain. This is the Taco theory: Trump Always Chickens Out. But why doesn’t that translate to resurgent growth hopes, higher yields and more expensive oil? - Rob Armstrong – Financial Times.
Should ordinary US retirement accounts be investing in private assets? Some worry that PE funds could become a dumping ground – Financial Times
Is private equity becoming a money trap? Lack of exits for deals struck by managers in frothy times is straining the business model of the asset class- Financial Times
We wrote a note on Blackstone Inc in January which shed a light on the extraordinary growth in the last three decades of both the company and its industry. The note can be found here.
Blackstone and its rivals have raised billions of dollars and invested in a whole range of private assets including Private equity, Real Estate and Private Equity. They have been immensely successful and Blackstone Assets under management are over $1trn
In the 1990s/ early 2000s, growth was powered by easy liquidity which drove inflows and buoyant stock markets which enabled profitable exits. After the global financial and banking crisis, real estate values collapsed, and interest rates and bond yields became near zero for a decade. This created prefect period for leveraged investments in housing and Blackstone and the other alternative asset managers plied into real estate. Blackstone became the largest owner of single- family homes in the USA.
The collapse of banks in the global financial crisis led to much tighter capital regulations on banks which made lending more expensive.
The alternative lenders saw a huge opportunity in private credit and that became a huge source of asset growth. Private asset growth completely outpaced public markets.
The growth was absolutely phenomenal. By some measures, Alternative Asset Managers has $11trn worth of assets by 2021/22.
Perhaps history will see 2021 as the high-water mark of this trend. That was when new fund raising peaked at $250bn with Blackstone’s garnering a large part of it. Stephen Schwarzman’s personal total compensation in 2021 was $1.1bn.
However, nothing succeeds like excess and nothing exceeds like success.
New money pouring in had to be invested. Too much money was chasing too few opportunities and the valuations at which purchases were made were excessive. The alternative managers had to invest their new capital – they are not paid their high fees for holding Treasury Bills. Warren Buffett at Berkshire can hold $370bn in T-bills as he charges no fees!
In 2022, the US Federal Reserve raised interest rates five times and the decade long experiment with cheap money was over.
This is a big problem for two reasons. Higher interest rates is a big problem for two reasons. The privately owned companies re heavily leveraged and their performance will deteriorate as rates increase. Secondly, most asset prices will tend to decline in the face of higher yields.
Although US stock indices recovered after the pandemic, the market for IPOs (perhaps except technology) was moribund and offered little chance of exit for the 12,000 companies held by the private asset managers.
The endowments, pension funds, sovereign wealth funds, family offices are over-allocated to illiquid assets. They do not want to put new money -they desperately want to exit.
Three years later it is clear that there needs to be new source of long-term money in the system. Where will it come from.
The alternative asset managers and their lobbyists believe the answer are the pension assets of average Joes. Schemes and occupational pension have assets and can offer an exit to big guys who are stick.
The asset managers have lobbied the US government for a long time and Trump administration is sympathetic. Let these pools of capital invest freely – what can go wrong?
The ageing boomers in the western world will need to draw their pensions in the future. The risk is they will not be able to buy milk or bread as their pension is in some illiquid fund, for which there no buyers.
The issue was considered in two recent articles in the Financial Times.
Should ordinary US retirement accounts be investing in private assets? Some worry that PE funds could become a dumping ground – Brook Masters, Financial Times
On the surface, the proposal sounds so attractive: give ordinary Americans the same investment opportunities that billionaires, endowments and sovereign wealth funds already enjoy.
Over the last couple of decades, the ranks of public companies have shrunk, while the number of private equity-owned businesses has quintupled, and private credit funds have muscled into lending.
PE assets alone topped $4.7trn last year, nearly twice the total in 2019. Many big institutional investors put 30 to 40 per cent of their money in alternative assets, as they chased outsized returns that were less tied to the stock market’s ups and downs.
But many ordinary Americans are shut out by rules that limit their access to funds that invest in private assets alongside public equity and bonds. Now Donald Trump’s administration could throw open the doors. The Securities and Exchange Commission is rethinking rules that limit funds with more than 15 per cent in private assets to wealthy investors.
And the White House may make it easier for corporate 401k plans, the primary US retirement savings vehicle, to put money into private assets as well. “For an American household that wants to set aside money for the long term, some portion of it should be in private assets because it’s such a large portion of the market,” says Michael Pedroni, a former US Treasury official who now runs the consultancy Highland Global Advisors. “If you can do it in the right way and find the right vehicle, it would be a good thing for fairness.”
But there is the rub. The recent enthusiasm for putting ordinary US retirement money into private assets comes at a time when institutional investors are falling out of love with the sector and are looking to cut back.
Several giant Canadian pension funds recently reported that their PE returns last year lagged behind their benchmarks and the industry’s total assets under management dropped last year for the first time in decades, as new fundraising plunged 23 per cent.
The problem for PE is that volatile markets, higher interest rates and now uncertainty over tariffs have made it hard for firms to sell or float the assets that they own. The funds may report fabulous paper returns, but they have so far failed to crystallise, leaving existing investors strapped for ready cash.
Private fund groups Blackstone, Apollo and KKR are seeking new blood. They have already teamed up with traditional asset managers to offer private funds to wealthy retail investors.
But changing the SEC and 401k rules would widen the opportunity. Not only could the $9tn retirement market be fertile ground for raising new private funds, but it also could juice demand for buying stakes in existing ones, known as “secondaries”, allowing institutional investors to get out. The potential for trouble is huge.
There is already evidence that retail private funds are paying over the odds, shelling out on average 4 per cent more last year for secondary stakes than traditional buyers.
Perhaps they are better at spotting good opportunities than those buying for institutional clients. Perhaps not. (Methinks the author is being ironic)
Even some in the industry are concerned. Thoma Bravo founder Orlando Bravo warned last week that retail PE funds could become a dumping ground and “end up saving these companies that people cannot sell”.
There are also questions around liquidity. In theory, retirement plans are long-term propositions, so investors do not need to worry about being unable to sell out quickly. In reality, early “hardship” withdrawals from 401k plans have doubled in five years to 4.8 per cent. Industry experts say that there will be safeguards: private assets would mainly be offered as part of “target date funds”. These invest in a variety of assets and become less risky and more liquid as the planned retirement date approaches.
But analysts predict that switching 15 per cent of assets in a target date fund could push up fees by between 30 and 100 basis points per year. That may not sound like much, but consider that the average expense ratio for target date funds is 68bp, and Vanguard and State Street charge less than 10.
It all adds up to this: retail funds appear to be buying into alternative assets at higher prices and they charge higher fees than public equity funds at a time when returns have been weaker. What comes to mind is Vanguard founder Jack Bogle’s observation that, “In investing, you get what you don’t pay for”. Buyer beware.
Lack of exits for deals struck by managers in frothy times is straining the business model of the asset class- Daniel Rasmussen Financial Times
US equity markets have had a banner run in the years since the Covid-19 market panic. Yet despite the S&P 500 surging nearly 95 per cent over the past five years, US private equity firms are struggling to profitably sell the portfolio companies they have accumulated — nearly 12,000, according to research by Cherry Bekaert.
At the current exit pace of 1,500 companies a year, it would take nearly eight years to clear the existing inventory.
Investors in private equity have seen distributions of capital collapse from the typical 30 per cent of net asset value down to only about 10 per cent of net asset value, according to Bain.
And frustrated investors in funds — most notably Yale and Harvard — are turning to the secondary market to sell stakes, while talk of “over allocation” and “above-target” investment in the asset class is spreading.
The most proximal cause of this roadblock is the excessive exuberance of the 2020-22 period in private markets, when valuations were booming and interest rates were still hovering near zero.
Private equity groups attempted to sell everything they had bought before 2020 into this frothy market, and then turned around and paid massive prices for new deals.
Deals between private equity managers peaked at about 45 per cent of total exits in 2022, according to Harvard Law School research. And now we are experiencing the hangover from this deal binge.
The pre-2020 deals that did not sell during this period are generally deeply flawed, while the new deals initiated in the period were done at such high valuations — and with business models that anticipated interest rates remaining low — that exiting them at a profit today is very difficult.
As exits have dried up, deeper problems with the asset class are being revealed. Private equity was the apple of most allocators’ eyes in the 2010s.
Fundraising seemed to rise inexorably and transactions between private equity managers became an ever-larger share of exits. But the allocations started to outpace the size of the market.
By my estimate, the addressable market for private equity — the companies it could buy — is only about one-tenth the size of the public equity market. Yet a 40 per cent allocation to privates, roughly where Yale’s endowment is, has become increasingly commonplace.
This represents a massive overallocation to a very illiquid asset class. With private equity fundraising experiencing a sharp drop in 2024, according to PitchBook data, and further slowing so far in 2025, this process is starting to reverse.
Less fundraising leads to fewer exits as there are fewer buyers within the industry, which, in turn, results in lower valuations and worse returns. Then allocators reduce allocations even further.
This would all be fine if there were other natural buyers for the private equity inventory of assets. But while the bigger US stocks have thrived, small and microcap shares have not performed as well.
Since 50 to 60 per cent of private equity deal value falls squarely within the microcap range of public markets, according to Ropes and Gray data, the initial public offering market is at present not an attractive option for many companies.
Financially, private equity-backed companies are under strain. The industry’s operating model relies heavily on leverage. As of 2024, private credit yields on leveraged buyout deals have climbed to 9.5 per cent, reports PitchBook. The vast majority of this debt is floating rate. I estimate that ratios of debt to ebitda for many portfolio companies now exceed eight times.
And a significant share of these businesses are cash-flow negative. This is the logical result of an environment where cheap debt enabled overpriced deals and masked operational fragility. And because these businesses are already overburdened with debt, they cannot buy growth either.
Moody’s reports default rates for private equity-backed companies nearing 17 per cent, more than double non-private equity firms. Private equity sponsors are playing for time by refinancing with new structures or selling their companies into so-called continuation funds to hold the assets. But kicking the can down the road can be a dangerous strategy if high-priced debt continues to erode equity value or economic growth slows further.
For years, private equity could do no wrong. But now it is starting to look like a massive money trap. It has underperformed the S&P 500 over one, three and five years, according to McKinsey.
The consensus on private equity is being quietly, but decisively, rewritten. The question now is not whether the model is being broken. It is whether the exit is wide enough for everyone trying to leave.
3/06/2025