Euromoney sits down with a private equity fund manager, a veteran of the investment banking industry, who has concentrated the firepower of the hundreds of millions of dollars former contacts have entrusted to him through their family offices in the fintech sector.
His views are reassuringly and profoundly cynical.
He sees so many supposed businesses that are just an app unburdened by any of the drudgery of dealing with actual customers that he no longer pays attention to them. There are a handful of more mature businesses that no longer fit comfortably in the regulated banking industry that he is prepared to provide late stage funding to, but he is looking for rare ones that can actually deliver profits and dividends.
That’s because the exit route is not clear. Private equity investors used to take a five-year view on buying, owning and selling companies. He suggests that creating value in such a short time frame is like buying a lottery ticket and expecting to win the jackpot: enormous odds against and pure luck if you do.
Fintech is just one sector of course. On a big-picture view, does this mean private equity sponsors have made a big mistake raising vast funds that they are struggling to invest?
He responds with a question of his own.
“Are you stupid?” (This is, after all, an old friend). “Of course, they haven’t made a mistake. No one is doing this for the 20. It’s all about the 2.”
In many markets, not just fintech, but also the M&A business, bankers are pinning their hopes on private equity sponsors now feeling the pressure to put vast funding already raised – the number $1 trillion is often bandied about – to work.
Don’t rely on that pressure, he suggests. Private equity fund managers earning 2% fees on multi-billion dollar funds for no work will be quite happy to keep doing that for as long as they can before handing the money back with a polite shrug that good value was hard to find.
Cambridge Associates, the global investment firm, suggests that the median net internal rate of return of global private equity funds declined from 20.2% in 1993 to 10.7% in 2015, yet the traditional fund fee structure remained essentially unchanged.
Smart institutional and ultra-high net-worth investors are already trying to bypass it when they can. Cambridge Associates notes that co-investing directly into investee companies alongside private equity, and so avoiding their fees, accounted for approximately $40 billion in US private investment activity in the past year.
That is around 20% of all US private equity investment.
Such smart investors also want to dictate their own timing for deploying capital and not be at the mercy of private equity funds.
The drawback is that to gain access to such co-investment opportunities, most investors must already be limited partners in funds charging 2 and 20. But co-investment is no short-lived trend. The industry structure around private investment in equity and debt is changing fast.