Private equity, especially buy-out shops, found themselves on the receiving end of unfavorable headlines this week. One of which came from the WSJ on Wednesday which reported a continuation of negative performance trends as measured by 3rd quarter YOY exit and new deal counts, trends supported by lookback comps from Pitchbook Data. Though somewhat expected given current market conditions, the performance KPIs were overshadowed by another, perhaps more problematic theme, brought to the fore by the Financial Times, also on Wednesday, who reported that LP’s were increasingly applying greater scrutiny to private equity borrowing strategies, of particular note, the use of margin loans and net asset value financing “to boost returns and distributions to investors”. The consequence of this practice, which unfortunately reeks of financial engineering, evinces increasingly negative sentiment from private equity LPs toward the asset class (again, specifically buy-out firms, growth equity shops seem to be performing better). The upshot? It’s tougher to raise capital for new funds.
Tangentially related to the above issues, was a September story from the FT (again) which added another layer of nuance to the negative investor sentiment creeping into the PE buy-out ecosystem, one that suggested that unlike its venture capital peers, private equity groups hadn’t yet taken its ‘lumps’ on asset valuation markdowns, and in fact were avoiding taking marks by selling off secondaries (LPs liquidating their positions) to large asset managers, like Goldman Sachs , at an “appropriate discount”. The strategy allows PE buy-out funds to forgo early exits with realized losses and/or markdowns on assets with implied returns below acceptable investor targets. The strategy was not lost on legendary AQR Capital Management quant fund manager Clifford Asness who (in typical Cliffy style) fired off a biting Tweet equating the under-the-radar liquidation of LP positions to “volatility laundering” (image above).
