On to New Heights: A Review of Bain’s 2018 Global Private Equity Report

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The best view to take in from the summit of a mountain is that of the next, taller mountain that you hope to climb in the future. 2017 provided quite a summit for private equity—awash with record amounts of dry powder and many lucrative deals—but taking stock of the successes and challenges of the past year will offer an ideal roadmap for how the industry can continue to prosper in 2018. Bain & Company evaluates the state of private equity in 2017 and discusses potential opportunities, obstacles, and strategies for the coming year in its 2018 Global Private Equity Report, available here.

A major theme of the report is the tremendous success of fundraising in private equity. The industry enjoyed a widely-reported windfall over $1 trillion in dry powder and posted a new record for fundraising driven largely by buyout funds. The final tally for 2017 indicates that, globally, firms raised $701 billion during the year, and in this timeframe, both the number of funds and their capital targets grew based on previous years’ levels. Furthermore, as Bain points out, of funds that closed in 2017, more than two-thirds met or exceeded fundraising targets and 39% closed in less than a year.

While Bain is careful to note that investors “are watchful for signs that the global market is overheating,” the report also shows that there’s little evidence to suggest interest in private equity is cooling. According to data from Preqin, 92% of investors with private equity allocations plan to devote at least the same level of capital, if not more, in the next year. Much of this investor confidence is rooted in results as private equity continues to outperform other asset classes.

However, the prosperity of 2017 and the optimism it’s carried into the beginning of 2018 don’t suggest private equity firms should become complacent. As competition over a limited pool of quality assets intensifies between firms with enormous reserves of capital, returns may flatten, so private equity’s recent string of historic successes means that the industry needs to develop new strategies and techniques for adding value.

Bain’s report suggests three potential paths for firms to establish new capabilities that will enable them to thrive. First, firms can improve their skills when it comes to assessing leaders and deploying talent into tailor-made roles that create value at all levels of the operation. Firms can also prioritize actively managing companies to achieve profitable organic growth instead of simply cutting costs or acquiring additional high-priced assets. Additionally, technology provides new opportunities for firms to conduct due diligence and analytics at lightning speeds, and they can take advantage of this in order to obtain insights, develop strategies, and take action faster than ever before.

Rekindling the Creative Spark of Investing

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I’m always reluctant to comment on articles that may be construed as advertisement for one particular firm. However, when I encounter an investment philosophy that matches my own—such as that of Bienville Capital, which was recently profiled in the article “Financial Engineers Killed the Art of Investing” by Institutional Investor—I can’t help but acknowledge how it resonates. Bienville’s philosophy is as close to my own as I’ve found, and I believe that there is as much art as science in investing.

In contrast to the endowment model of investing pioneered at Yale University and which is now ubiquitous, Bienville eschews traditional asset allocation strategies that do little more than push capital toward alternative managers. Instead, its model emphasizes a contrarian spirit and a willingness to step outside the box by exploring complex, often overlooked markets for unique opportunities that other managers frequently ignore.

In fact, such a maverick approach is increasingly one of the only ways to outsize risk-adjusted returns. The article’s author, Julie Segal, points out that the popularity of the endowment model has effectively commoditized alpha, depressing returns as hedge funds accumulate larger and larger reservoirs of capital. Therefore, nonconformity and a willingness to explore represent key competitive advantages for investors, who should be more open to contrarian ideas and look beyond contemporary cookie-cutter investment strategies.

Transcending the endowment and asset allocation models relies on stronger due diligence and discovery. That’s why Bienville developed a network of global experts, including consultants as well as other connections, to identify opportunities and share information. This allows investors to discover insights from an array of experts who can point them to potential areas of investment—and help them navigate their complexities—that would otherwise be passed over by others, and then they can then explore potential to generate outsized risk-adjusted returns.

Today’s investors rightfully prioritize alpha, but in doing so, they have pigeonholed themselves into investment strategies that ultimately lower the ceiling of their returns. By looking beyond the widespread endowment model and adopting a more contrarian spirit, investors can take a more creative approach to investing and enhance their returns.

To Infinity and Beyond: The State of Private Equity

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Private equity funds soared to new heights in 2017 and show few signs of slowing down in the new year.

According to a report by Preqin, 921 private equity funds reached a final close in the last year and secured $453 billion in investor commitments: a new fundraising record. In fact, as more data becomes available, Preqin acknowledged that the actual amount raised could increase by as much as 10%. A major catalyst of this fundraising were mega buyout funds of $4.5 billion or more—they secured an impressive $174 billion in investor commitments last year—as well as North American and European-focused funds.

Notably, the previous fundraising record was set in 2007 as 1,044 funds secured $414 billion in investor commitments. This context makes 2017’s fundraising that much more impressive since fewer funds were able to secure an even larger supply of capital, thus highlighting the strength of private equity as an asset class today.

Funds also flew past another milestone in 2017 as the amount of dry powder, or committed but undeployed capital, exceeded $1 trillion for the first time. Despite this tremendous reservoir of capital, a report from PitchBook found that 52% of private equity professionals plan to raise a new fund this year with the hope that any new funds will raise at least as much as previous funds. GPs and other private equity professionals must feel an incredible level of confidence in their products and potential in order to raise additional funds, and furthermore, this also signals confidence that investors will continue to commit to new funds despite mountains of existing dry powder.

Additionally, the PitchBook report also noted that 70% of GPs do not intend to offer “special incentives,” including fee breaks or co-investment opportunities, to investors who make early or large commitments, which indicates GPs and funds still hold most of the cards in fundraising negotiations.

Private equity’s recent successes appear to validate predictions by experts that the asset and wealth management (AWM) industry will grow spectacularly throughout the coming decade. In an earlier blog post, I discussed a report by PwC profiling the future of the AWM industry, which predicted that total assets under management will practically double from $84.9 trillion in 2016 to $145.5 trillion by 2025. With private equity setting new fundraising records and accumulating unprecedented amounts of dry powder, PwC’s vision for the future of AWM seems to ring true.