May 23, 2022 - Economy

Private equity's fundraising flux

Illustration of line graph turning into a question mark

Illustration: Eniola Odetunde/Axios

Private equity fundraising for the past decade has been monolithic in its ease, with humility as the only real limiting factor. But now there's legitimate uncertainty.

Why it matters: Private equity fundraising cycles are long, so what happens today could impact deal activity for years to come.

The big picture: Most limited partners in PE funds typically invest based on a target allocation to the asset class. This could be anywhere from a few percentage points into the double-digit range (public pension giants CalPERS and CalSTRS each recently boosted their target PE allocations to 13%).

  • When stock markets are soaring, these percentages translate into bigger dollars. But when stock markers sink, so too does the PE allocation's buying power. This is the so-called denominator effect.
  • In theory, the stock market correction should mean that many institutional investors are suddenly over-exposed to private equity. It's why many publicly listed PE firms have seen their own share prices fall, as investors are concerned that new funds will be harder to raise, thus slowing the creation of new fee streams.
  • In practice, however, not everyone is slamming on the brakes. Partially because some LPs expect a public equities rebound. Partially because some LPs are scared of baling on long-term partners who've made them lots of money.
  • Or, as one major fund manager told me this morning: "Everyone says that the denominator effect is making fundraising harder, but then adds that 'it must be hitting everyone else because it's not impacting me.'"

The most fortunate firms, of course, are those that aren't in market. A close second are those focused on active areas like energy or turnarounds.

The least fortunate would, at least in theory, seem to be those focused on areas like growth tech, due to valuation tumult. Or at least second-tier players in those markets, as top-tier firms tend to hurdle the denominator effect.

What to watch: Q2 fundraising numbers, which we should get by the middle of July.

  • That data will largely include final closes of funds that secured most of their commitments before the new normal, like the recent $14 billion fund from Clearlake (which only targeted $10 billion), but it also could reflect delayed fund closes or other difficulties.
  • If we do see a significant drop-off, then it means the optimists are just talking their books. If we don't, then it may be another example of how private equity is structured to float over short-term economic waves.
Go deeper