A new report from McKinsey finds that in 2016, private markets again defied expectations. But competition is getting tougher for both managers and investors.
In 2016, the most exciting news for private markets may have been what didn’t change. In these markets—mainly private equity, but also closed-end real estate, infrastructure, natural resources, and private debt funds—investors’ desire to allocate remains strong. Our long-running research on private markets finds that, whether performance is measured by fundraising (firms received $625 billion of new capital in 2016) or assets under management (AUM), now $4.7 trillion worldwide, 2016 was another impressive year in a long cycle of expansion that began in 2008. The industry continues to provide a source of excess capital for investors; in 2016, distributions outstripped capital calls for the fourth year running. New entrants continue to flock to the industry, and the number of active firms is at an all-time high.
While more fundraising, an increase in AUM, and greater capital distributions to investors are trends to celebrate, growth also presents challenges. The larger number of general partners (GPs) reflects the industry’s success but also heralds increased competition, which has contributed to rising deal multiples. As GPs have become gun-shy about today’s higher prices, deal activity has fallen, and dry powder has reached an all-time high—though our research suggests that dry powder is not nearly the problem that some have suggested. In fact, in this and other ways, the industry is overcoming its growing pains and finding new ways to deliver for its investors.
Our research included interviews with executives at some of the world’s largest and most influential asset managers, which revealed several common expectations for 2017. All acknowledge that an extraordinary number of wild cards are now in play, especially in geopolitics. While these unknowns will create opportunity for some, most GPs acknowledge that this sort of uncertainty is very difficult to price. As one CEO told us, “Some of these changes in the US will raise the base case for GPs, but the tails are very fat.”
Most agree that public markets, despite their recent run-up, are becoming structurally less attractive to many limited partners (LPs), who will likely respond by further raising their allocations to private markets. Creativity in fees and products will flourish, producing a range of options: we will still see full-service GPs offering closed-end funds, of course, but also more LPs in co-investments, more separate accounts, and at least a few more LPs investing directly. Finally, most executives believe emerging markets will normalize following the recent period of turbulence and will start to look more like the industry in developed markets.
As the challenges grow, we see four ways for GPs to prolong private investing’s remarkable ride: more proactive and creative sourcing, greater conviction in due diligence’s findings, new operational approaches to the portfolio, and greater flexibility in exit timing.
McKinsey’s Private Equity and Principal Investors Practice is pleased to publish A routinely exceptional year: McKinsey Global Private Markets Review (PDF–1.30MB), which details these and many other findings.