Cambridge: Industry has a $445bn overhang

The private equity industry has about $445 billion in uninvested capital poised for deals, with about half of the untapped money in the hands of large firms with $5 billion or more in commitments.

The presence of such a large amount of capital, confined mostly to the buyout space in large to mid-sized funds, could lead to several changes in the industry, including style drift and a possible “bifurcation” of returns in investments made during the peak of the buyout boom and deals done in the trough, according to new research from Cambridge Associates.

Much of the overhang, or about 75 percent, is housed within funds raised in the period from 2007 to 2009, Cambridge said. On average, funds raised in 2007 are about 25 percent called, those raised in 2008 are about 15 percent called and funds raised in 2009 are less than 5 percent called, Cambridge said.

“It’s still early days for a lot of this overhang to deploy itself,” said one of the authors of the report, Andrea Auerbach, a managing director with Cambridge.

Some managers may be feeling pressure to start investing the enormous amounts of capital they have on hand, especially with limited partners grumbling about paying fees in the face of no investment activity. But in the absence of a vibrant deal market, the overhang will take years to spend, according to the study.

Private equity firms have really been in the middle of this [downturn], working with portfolio companies, trying to determine the best use of capital, figuring out what kind of audibles to call with portfolio company management. Andrea Auerbach

The authors calculated that if the deal market returns to its 2000 to 2004 levels, and that the average equity contribution for deals is 50 percent, funds with $5 billion or more in commitments could take more than 15 years to invest existing commitments.

Using the same calculations, funds between $1 billion and $5 billion in size would take about eight years to invest committed capital, and those with less than $1 billion would take about six years to get through all the capital, Cambridge said.

“This overhang doesn’t appear to be a material concern for funds under $5 billion, particularly for funds under $1 billion,” Auerbach said.

Certain factors will help whittle down the overhang, Auerbach said, including the opening up of the capital markets for deal activity, and the expansion of geographic scope for deals into other countries.

Firms that might not be active in the US with their capital may be active in Asia, Latin America or Europe, she said, which would help a firm put some of its committed capital to work.

Also, some managers are expanding beyond their stated strategy to put capital to work and trim down the overhang, she said. “A portion of private equity fund capital might be deployed in distressed opportunities, or growth equity both abroad and at home, or PIPES,” she said. “So all those different things can whittle down this overhang into something less alarming.” Auerbach said managers have been approaching LPs to expand their strategies in certain cases.

LPs may experience a “bifurcation” of results in a portfolio, in which a firm that invested quickly at the height of the market generates different returns from investments made in the trough, the report said.

“Private equity firms have really been in the middle of this [downturn], working with portfolio companies, trying to determine the best use of capital, figuring out what kind of audibles to call with portfolio company management,” Auerbach said. “Their investors have really had a chance to see what their managers are like under significant pressure.”