Private equity fund values are expected to plummet by more than half in 2009, with well-known large buyout funds performing little better than less well-known ones, an analysis by Pensions & Investmentsshows. No matter how you slice the existing data — be it the analysis of publicly traded portfolio companies, returns of publicly traded private equity funds or secondary market valuations — private equity returns are in for a steep decline, just when investors could use them most.
A drop in returns might lead investors to pull back from the asset class, according to at least one study.
“Pension funds will be pulling back from private equity because their returns will be terrible,” said Steven Kaplan, Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business.
Private equity returns have not begun to take a serious fall yet because few private equity firms have written down the value of their portfolio companies. But the data might make this stance difficult to maintain in 2009:
• Prices of interests in private equity funds on the secondary market are down an average 39 per cent of net asset value in the second half of 2008 from 91.1 per cent in the second half of 2007, according to a study by Cogent Partners of Dallas, released last week. The average high bid fell to 61 per cent of net asset value from 102.2 per cent in the last six months of 2007; the average median bid dropped to 55.2 per cent of NAV from 91.6 per cent; and the average low bid, to 50.1 per cent from 79.5 per cent. Brand-name buyout funds failed to garner better prices, with an average high bid of 63.3 per cent compared with 60.4 per cent for lesser known funds.
• Publicly traded private equity funds values were down 74.9 per cent during 2008. Shares in Fortress Investment Group and KKR Financial Holdings, the private equity firm’s public debt vehicle, had sunk below $1 in December.
• While the actual value of companies taken private can’t be ascertained, the value of comparable publicly held companies to those taken private in leveraged buyout deals between 2005 and 2008 plummeted an average 51 per cent as of December 31.
Kaplan says pension funds won’t be happy with the ‘terrible’ returns in private equity.
While nobody expects private equity returns to be positive this year, some institutional investors are more prepared for a smaller initial drop in valuations, to around 20 per cent at the end of the first quarter, declining to between 30 per cent and 40 per cent by year end, said Stephen Nesbitt, head of California-based asset consultant Cliffwater.
To perform valuations of their portfolios, private equity firms generally will look at earnings before interest and tax as well as ‘multiples’ or earnings growth times the amount of equity invested.
“There’s no escaping the fact that last year and particularly in the last quarter, there’s been a decline in both of those,” Nesbitt said. “If things stay the way they are today in terms of the public markets, 50 per cent may be overstated, but we’re looking at between 30 per cent and 40 per cent, with 50 per cent the bottom.”
Private equity fund managers would not be dropping the valuations of their portfolios at all were it not for new accounting rules requiring them to mark their portfolios to market, Nesbitt acknowledged.