PE Fund Closings Slide In Q3 But Look Set To ReboundBy Benjamin Horney October 7, 2016
There was a significant dip in private equity fund closings in the third quarter as the industry grappled with increased competition, as well as uncertainty related to the global economy and U.S. presidential election, but experts say the numbers will go up as the end of 2016 draws near.
In the third quarter, there were 69 fewer fund closings worth a total of $51 billion less than the second quarter, according to data from research firm Preqin. A slight dropoff in fund closings is natural because industry players tend to do a majority of their spending during the first half of the year, experts say.
"Historically, the third quarter is slower than the fourth quarter," Howard Berkower, a partner in McCarter & English LLP’s corporate practice, told Law360. "I think that fundraising will pick up in the fourth quarter."
That said, this year’s slowdown is a little more noticeable than usual, according to Peter Martenson, a partner at placement agent Eaton Partners.
"People have stepped back a little more," Martenson said. "They’ve taken their foot off the gas pedal a little bit to wait and see what happens with regards to a number of different items that impact the industry."
Industry insiders attribute the third-quarter fund closings slide to a number of factors, including an increasingly crowded fundraising market. That sentiment is backed up by the numbers as there are currently 2,935 funds seeking a total of $983 billion from investors compared with 2,798 funds seeking a combined $938 billion in July, according to Preqin data.
Private equity players can combat the increasingly crowded fundraising marketplace by focusing on specialization, Martenson said, because today’s investors are seeking to direct their money toward funds that are very specific in their focus and have pinpointed an area that isn’t already completely congested.
"You really have to be good and have a specialization that you can articulate to investors," Martenson said, pointing to finance litigation as one example of a niche-type fund that is becoming more popular amongst the private equity community.
Meanwhile, unease over how the upcoming U.S. presidential election will play out has had a pretty significant dampening effect on fundraising activity, experts say. Mayer Brown LLP partner Jeffrey A. Legault told Law360 that he believes it to be the "main contributor to the reluctance of private equity sponsors to pull the trigger on deals in the U.S. in the third quarter."
The U.K.’s vote to withdraw from the European Union, which took place just before the start of the third quarter, is another factor that affected the number of fund closings, as is the still-unraveling saga over claims that Deutsche Bank AG misled consumers into buying risky mortgage-backed securities in the lead-up to the financial crisis in 2007, Legault said.
However, he does not believe that either will have significant long-term implications when it comes to private equity fund closings.
"The initial shock of Brexit is behind us and the impact on the U.S. has clearly been minimal, and while it’s impossible to say with certainty what will happen with Deutsche Bank, the consensus seems to be that European governments would not allow it to fail," he said. "So I’m optimistic that come November, all of these headwinds will be behind us and a more normal level of activity will resume."
Private equity fund managers can take some solace in the fact that a number of the reasons for the third quarter’s stagnation will likely no longer be of concern in a month’s time, but there still exist difficulties when it comes to raising and closing funds, experts say. The fourth quarter will likely see a reversion to the mean, but that doesn’t mean that private equity players can relax.
Challenges remain, and the most successful industry players will be the ones that are able to stay a step ahead of their peers, experts say, either by finding a niche that no one has yet taken advantage of or picking the right sectors to focus on at the right time.
For instance, now might not be the best time to launch a real estate or credit fund, according to Preqin data. There were 32 real estate fund closings worth a combined $19 billion in the third quarter, the data shows, down from 46 funds worth a total of $31 billion. Private debt funds also slid, with 22 such investment vehicles worth a total of $9.6 billion closing in the third quarter compared to 33 funds worth a combined $20 billion in the second quarter.
"People are looking at real estate and saying, ‘It’s pretty fully priced, and we already have a big exposure to it. Maybe we don’t need to put more money into it today,'" Martenson said. "It’s the same a bit with credit."
Hot sectors that aren’t yet completely jam-packed with funds competing for investor dollars include infrastructure, biopharmaceuticals and others, according to Martenson, and it won’t be long before funds are raised for particular niches that no one even knows about at the moment.
While the third quarter was a bit of a struggle for private equity fundraising, the forecast for the fourth quarter and beyond is relatively sunny, according to Berkower, because finding ways to capitalize in even the toughest of conditions is what the private equity industry is all about.
"While it may be more difficult to find good deals, institutional investors continue to chase higher returns to meet their long-term funding obligations," Berkower said. "And private equity is the best game in town."