Dry powder in LBO funds could protect them in recession – report

Capital calls in US and European buyout funds fell below 5% in vintages 2017-19, compared with over 15% in the years before the GFC.

Private equity firms’ cautious deployment of capital in the two years prior to the covid-19 pandemic could be a boon in the near term, a study has found.

As economies across the globe enter into recession, the dynamics of capital calls and distributions in recent years could “significantly insulate leveraged buyout funds from the wider economic malaise”, according to research from data provider eFront.

The report, Private Markets in Downturns: 3 Observations, analysed capital calls and distributions in the run up to the global financial crisis and found capital calls spiked in both the US and European buyout markets in 2006-07.

US buyout funds called 16.3 percent of committed capital in 2006 and 19.1 percent in 2007. European buyout funds meanwhile called 16.5 percent and 15 percent during the same period. According to the report, many of those investments did not perform well during the crisis as these LBO funds put “huge sums of capital to work at the top of the market”.

In contrast, capital calls fell below 5 percent in both markets in 2018-19, indicating that funds in recent vintage years have not been rushing to deploy capital early in a highly priced market, the research revealed. This means the impact of the pandemic on existing portfolios is potentially limited and investors have large pools of dry powder to make new acquisitions.

The number of global buyouts remained flat at 3,600 deals last year, compared with a previous high of more than 4,000 deals in 2007, according to Bain & Company’s latest PE report. Global buyout deal value has bounced around since 2015, due to stiff competition from corporate buyers and rising asset prices.

PE dry powder or uncalled capital has been rising since 2012, according to Bain, and hit a record high of $2.5 trillion in December 2019 across all fund types, with $830 billion available for buyouts alone.

Another explanation for a relatively low level of capital calls may be the use of equity bridge financing or subscription line facilities, eFront noted.

Hypotheses will soon be tested as the coming months provide more clarity on the impact of the pandemic on PE portfolios.

“Whether this was a result of luck, judgement or intuition, the industry appears exceptionally well placed to invest into any recovery,” eFront noted, adding that those that do so quickly will reap the most benefit.