Industry hit by $5tr wave of capital

Vivek Pandit, director at McKinsey & Company says huge capital inflows expected over the coming years and increased direct investing are shaking up the private equity industry.

With as much as $5 trillion expected to flow into private equity by 2020, the industry has reached an inflection point that would see an expansion of competition, Vivek Pandit, director at McKinsey & Company said at PEI’s Direct Investor Summit in Hong Kong.

“If you look at capital inflows, we anticipate in the next five to 10 years that roughly $5 trillion of additional capital will come into private equity. That is more than we’ve had in the history of PE and that’s certainly putting a lot of pressure on those who need to put money to work.”

With that much capital vying to win a place in a newly competitive era, Pandit sees an “expansion, rather than a winnowing” of competition, as firms compete on absolute returns, consistency of returns, pricing, scale, specialised knowledge, and access to co-investments, among other things.

A McKinsey & Company survey found that in 2015 the total value of direct or co-investment deals involving limited partners jumped to 22 percent or nearly $150 billion. LPs are putting in more resources for direct investment capabilities and increasingly want solutions more than just products. Instead of just participating alongside general partners, they are, in fact, starting to match their terms of reference with investment opportunities they believe GPs are not providing them.

This has also changed their view on GP selection, Pandit added. “It’s shifting very quickly from a ‘let me find the highest return player view’ to ‘let me find scale players that can deliver consistency at that scale’.”

This shift in mindset has forced limited partners to think more about costs. A McKinsey analysis showed that on equal weighted returns, direct investments have done better than co-investments and fund investment benchmarks, averaging 30.2 percent returns compared to 18.9 percent and 17.4 percent, respectively.

“PE is a very attractive asset class but we think what’s more important now is how we think about returns. From the LP perspective, I think it’s become very clear that consistency at scale is the new alpha. Investors are looking for strong consistent returns on a large mandate.”

Pandit pointed out that the rate of innovation will continue, as will the move away from an average fee structure to a performance structure.

“PE buyouts used to be the centre of the PE universe, it is not much more so today. Many more scale sectors like distressed credit, real estate, and infrastructure are growing much faster, and this is what LPs now are trying to build,” he said.