PLANSPONSOR - October/November 2019 - 49

ranged from about 20% to 50% annually,
while bottom quartile managers turned
in a range of about 0% to negative 30%.
Beyond the prospect of lofty returns,
private equity also offers diversification
from what is available in the public
markets. " There are a lot of types of private
equity, " observes Bob Morgan, managing
director at 50 South Capital in Chicago, a
subsidiary of Northern Trust. " Late-stage
venture capital might have high correlation
to the returns and valuations of the
public market, but we look in the lower end
of the middle market, and those smaller
businesses are insulated from what is
happening in the private markets. The
CEO of a $100 million business is worried
about hiring the next salesperson, not
what's going on in Saudi Arabia. It's more
about the skills of the management team
and their strategic goals. "
All of that capital flowing into private
companies, plus rising public markets,
has put pressure on the pricing of private
deals. Preqin, a private markets research
firm, conducts regular surveys on its
investors' intentions and found that, in
June, 79% of investors saw high asset valuations
as a key challenge to private equity,
and 59% were concerned about competition
for investible assets. McKinsey &
Co. notes that private equity firms had
about two years' worth of " dry powder, " or
capital on hand yet to be invested.
In its 2019 investment outlook,
Cambridge Associates stated, " Generally
speaking, we are more enthusiastic
about private than public opportunities,
though we are not enthused about the
$300 billion mound of dry powder in
the former, and suggest being especially
selective in popular strategies such as
direct lending. "
Investors cannot seem to get enough,
though. Preqin also says that 40% of
current private equity investors expected
to increase their commitments to the
asset class, up from about 30% in the
preceding two years. Because private
equity funds have a finite life of seven to
10 years, investors have to repeat annual
commitments to maintain their allocations,
as well as to keep their place in line
with the managers they choose.
" The high prices are making it
difficult for existing investors who are
committing less to get access to the
high-returning funds, " notes Jay Love,
a partner in the Atlanta office of Mercer
Investment Consulting. Accordingly,
investors are streamlining their holdings.
" Historically, sponsors have seen that
80% of their returns are driven by 20% of
the managers, and plans that have been
investing in private equity and debt for
10-plus years have been paring back the
number of managers, to really focus on a
core private portfolio. "
The Popularity of
Private Debt
Private debt is a relatively new asset
class for institutional investors, getting
a growth push from the regulatory pressure
on banks, following the financial
crisis. " Private credit is a great benefit to
the economy, " contends Stephen Boyko, a
partner in the Boston office of the law firm
Proskauer Rose LLP and a private debt
specialist. " It has filled the void created
when banks significantly reduced their
exposure to leveraged finance during the
Great Recession. And managers of private
credit are patient sources of capital willing
to put money to work to help companies in
trouble, resulting in fewer bankruptcies
in middle America. "
It is also a source of solid returns.
" Pension plans aren't getting much yield
from their conventional fixed-income portfolios,
and in the last five years there has
been an explosion in demand for private
credit and the mix of offerings that's
available, " says Sheila Ryan, a partner
in Cambridge Associates, in Brookline,
Massachusetts. " Some institutions keep a
dedicated private debt allocation, and most
of that is coming out of their fixed-income
or hedge fund allocations. " She says
expected returns for private debt vary by
strategy, but, for middle-market corporate
" ... enthusiasm
for private
equity is
understandable.
Returns have
outpaced
those of the
public equity
markets,even
after eyewatering
fees. "
loans that make up the bulk of the market,
returns can reach 5% or 6% and as much
as 8% with leverage.
Private equity fund values have
risen seven-fold in the last 15 years, says
McKinsey & Co., and private debt has
mushroomed into a $480 billion market
in a decade. How much capital can the
private markets support, and what will
they look like in 2030?
" We'll see more evolution in the
strategies, with more and more niche
markets, " Ryan says. " We'll see growth in
evergreen private equity vehicles where a
manager will buy a company and hold it
longer than five or six years. " She adds,
" The European private debt markets are a
few years behind the U.S., and we expect
to see more in Asia. "
" Plans will continue to need to earn
a premium to what they get from the
public markets, so I can't see why plans
would decrease their allocations, " says
Raelen Lambert, global head of private
debt at Mercer Investment Consulting in
Sacramento, California. " I think we'll see
more creativity, and in 10 years these asset
classes will be even more mainstream. "
-John Keefe
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