“It’s been at the top,” Hunter says, commenting on the type of managers finding it most difficult to move on from the financial crisis. The mega-buyout funds, each managing in excess of $4.5 billion, are in the most strife – particularly those that rapidly spent the capital raised in the booming years of 2006 and 2007. Many of the funds that put capital into highly leveraged investments are now in distress: there is little hope of a supportive exit into public markets or another private buyer, banks are policing debt agreements strictly, and fresh capital is hard to come by. Managers can get caught in a “negative feedback loop”, in which commitments can no longer be funded, Hunter says. “These sorts of things can cause the implosion of a private equity firm, which tends to be slower than a hedge fund event.”
Preqin, an alternative investments researcher, finds the aggregate performance of mega-buyout funds has endured a precipitous fall to become the worst performers among private equity managers. While their collective five-year internal rate of return (IRR), or the rate of growth their investments are expected to generate, is more than 20 per cent, over three years it becomes marginally negative and their oneyear performance nosedives to -30 per cent. But some big shops will have enough capital to survive until markets become less hostile. Hunter says one such manager spent all of its capital on 2006 vintage assets, primarily in consumer and retail businesses, which suffered heavily in the crisis. But the manager was able to raise a second fund in the first half of 2008, which it ultimately used to stabilise its earlier, troubled investments – good news for investors in the first fund, but not for the newcomers.
“They did two to three years of cost-cutting in one quarter,” and changed the management of the company, because “the team you need in a rising market is different to what you need in a down market,” Hunter says. The manager then devoted one-fifth of its staff to find new investments, and the other four-fifths to keeping existing assets alive. “They stabilised the portfolio, and no companies failed. They lived to fight another day.” “Now we’re in another day. Private equity can be a slowmotion train wreck, and many of these problems are still playing themselves out. “If they get their money back, they’re saying that they’ll be fine, and that reasonable outcome will be defined as getting their money back with a small amount of profit or small loss.”