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European buyout executives are prioritising distributing cash to their backers over delivering market-beating returns on their investments, after they have been forced to hold on to their assets longer than planned because of higher interest rates.
Gathering at the IPEM conference in Paris this week, fund managers said the new acronym by which they lived was “DPI” — distributions to paid-in capital, or how much money a fund cumulatively gives back to investors relative to what they originally paid in.
The measure has superseded the once sacrosanct internal rate of return, which the private equity industry long favoured to demonstrate it could deliver public market-beating annual performances.
“DPI is the new IRR,” said Tristan Tully, head of European private equity at Brookfield during one of the panels.
The metric was the new “magic word”, echoed Tully’s Carlyle counterpart, Michael Wand. It was clear distribution multiple had “replaced net IRR” as the industry’s key measure of success — as “it should” because exits had been neglected in the past few years, he added.
The internal rate of return has historically been the main metric by which private equity managers and investors alike judged fund performance. Many used to aim for at least 25 per cent per year to justify their hefty management fees and the 20 per cent share of profit — carried interest — that they typically levy on asset sales.
But buyout professionals have recently been pressured to focus their attention on the amount of money they hand back to investors, after higher interest rates impacted company valuations, making it harder for private equity firms to exit their investments.
Private equity groups globally are sitting on a record 28,000 unsold companies worth more than $3tn, a report by Bain & Co found in March.
A drop in distributions has left the financial institutions that invest in private equity with less money to allocate to future funds. New data released this week suggested that this tightening of purse strings is disproportionately affecting the smallest private equity managers.
Global private equity funds aiming for less than $100mn in commitments raised only $1.8bn between them in the first six months of this year, compared with $7.7bn in the whole of 2023.
Contrastingly, “megafunds” aiming for more than $5bn in pledges attracted more than $156bn in the first half of 2024, according to PitchBook. This would put them on course to raise more this year than any other in records going back to 2008.
“Some firms will struggle in tough times,” said Mattia Caprioli, co-head of European private equity at KKR.
He added that firms with “diversified” sources of funding and strategies could more easily smooth some of the “tensions” between distributions and fundraising.
There will be a “shaking out” in the market of “managers with mediocre returns who could get bags of money in 2021 and are not finding it as easy now”, said another executive at an international multi-strategy firm.
It was mainly the “mid and lower market” private equity funds to which they were “refusing” to give more cash, said a senior manager of a Switzerland-based family office on the sidelines of the conference.
Some “middle of the league table” firms were now launching vehicles with fundraising periods of two years, instead of the usual one, noted a lawyer.
William Barrett, managing partner of Reach Capital, which aims to match mid-market private equity funds with investors, added that fundraising “is tougher today” for generalist players “as it is harder to differentiate themselves”, whereas “specialists are doing fine”.
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