Yale wants out. Four years ago, half of its assets were invested in various illiquid markets, mostly in private equity. This year, the university is looking to sell roughly $6 billion worth of private-equity (PE) assets, 30% of the total in that sector and 15% of the fund’s overall assets ($41.4 billion), says Bloomberg. It is not alone. Harvard is looking to sell $1 billion worth of PE assets and, according to the Financial Times, Canadian and Danish pension funds have been loath to put any new money in, as have some of China’s big funds. Overall, fundraising was down last year for the third year in a row.
You can see why. PE has had a brilliant couple of decades, outperforming the S&P 500 nicely since the millennium. When debt was cheap and PE relatively niche, buying companies on borrowed money, restructuring them (borrow more, cut costs) and flogging them on for a fortune made a lot of sense (and a lot of money for investors and high fee-charging managers).
But now, with rates not going back to anywhere near zero any time soon, and the economic environment more fragile than it was, valuations look too high, and the “flog-on” part of the equation isn’t working. No one wants to sell their companies cheaply on the secondary market. The few deals done recently took place at an average discount to stated net asset value (NAV) of 10%. So there has been, as consultancy Bain politely puts it, “persistent sluggishness in exit volume” over the past few years, and the stockpile of unsold deals just keeps growing. It now runs to around $3 trillion.
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At the same time, distributions paid by funds from sales are running at about half their normal levels. You could say this doesn’t matter, but in the world of PE, it does. Without distributions, there isn’t enough money around for new deals – particularly if the institutions aren’t putting in new money, which they mostly aren’t. No wonder, says Bain, that the “outsize capital flows the industry got used to before the pandemic are unlikely to resume in the near future”.
Pension savers are coming to the rescue, whether they like it or not
So what next? If the big investors are getting out, who is getting in? Maybe you. In the US, PE has a firm eye on ordinary people’s retirement savings. There is upwards of $12 trillion in the sector, money the PE industry reckons it could put to excellent use. Rachel Reeves is on their side. She reckons UK savers’ pension money could also find a happy home in PE. This week, 17 of the UK’s big pension funds pledged to put at least 10% of assets in their default funds (your assets, just to be clear) into private markets – to include unlisted start-ups, with at least half of that (roughly £50 billion) being in the UK.
This could be entirely voluntary. Maybe the UK’s pension funds are a bit behind Yale and genuinely think this is a good idea (at present, they only have about 2% in PE). Or it could be that the UK’s pension funds are jumping before they are pushed. There is, says the FT, a “backstop plan”. If the money doesn’t move, Reeves will be legislating to create a “reserve power” to make it move.
There’s also growing chatter about the same sort of idea being applied more widely – one ex-pensions minister thinks the British state should go “bold” and insist that at least 25% of all new contributions to pensions be invested in the UK, in unlisted and early-stage companies as well as listed.
So, should you be happy about this? The first thing to say is that it isn’t yet entirely clear what investment in private markets will mean in this context; infrastructure projects are likely to be part of the deal. But in any case, it is clear that some of your money will soon be in PE.
The second key point is that the PE funds, the pension funds and Reeves think you should be happy about the plan. Here is Reeves on the matter: “I welcome this bold step by some of our biggest pension funds, which will unlock billions for major infrastructure, clean energy and exciting start-ups — delivering growth, boosting pension pots and giving working people greater security in retirement.”
Thirdly, there is a problem. As Reeves should know, past performance is no guide to future performance, and that is particularly the case when the asset class in question has made a large part of its returns as a result of circumstances that aren’t coming back (near-zero interest rates). Leverage and market multiple expansion (valuations rising at least in part because of low interest rates) drove 61% of investment returns for buyout deals from 2010 to 2022, according to consultancy McKinsey.
That’s nice. But what happens without very low rates? Look at the past few years and you get a hint – PE returns came in at 3.8% in the first nine months of last year (on McKinsey numbers again), “well below the historical average of roughly 14.5% since 2010”. UK investors will almost certainly be told over the next few years that PE has a much better performance record than listed equity – and that it’s a must-have diversifier. They probably won’t be told that its performance may not be repeatable in this environment.
They also won’t be told that for all the grandstanding that comes with PE, it’s just equity – except with a lot more leverage, a lot less transparency and significantly higher charges. Or that their money is, in part at least, filling a gap left by institutional investors. All in all, if it’s equity you’re interested in, why not find a pension provider prepared to stick with funnelling your money into cheap, relatively liquid listed companies instead – and for a rather lower fee.
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
