Mega-funds revisited

That so-called mega funds have been difficult to raise in the last two years should be news to no one. But a number of “rethinks” to recent fundraisings have given industry insiders cause to question whether the giant pools of capital raised during the boom era – such as the $19.8 billion fund raised by TPG or the $17.6 billion raised by Kohlberg Kravis Roberts, both in 2008 – will ever be seen again.

“I think investors remain unconvinced that plus $10 billion vehicles can really deploy capital in an effective manner to generate high returns,” says Kelly DePonte, partner with placement firm Probitas Partners.

One firm to hit the mega-fundraising wall has been Lone Star Funds.  It came to market looking for a total of $20 billion for two funds last year. Those targets didn’t last, though, as the firm conceded to the realities of the day and chopped the targets to $4 billion each.

The Blackstone Group has also fallen foul – albeit to a less dramatic extent than Lone Star – of the climate. The firm is soon to close on its sixth fund, which it expects will total $13.5 billion, well short of its original $20 billion target, and even a little shy of its revised target of $15 billion.

Meanwhile, The Oregon Investment Council, an institution with one of the longest limited partner track records in the US, has announced that, in order to diversify its large-cap holdings, it will be scaling down its commitments to long-time general partner Kohlberg Kravis Roberts (see p. 78 for more details).

LPs are concerned that such large pools of capital won’t be able to find the deals on which to spend the money, especially in today’s leverage environment, where debt is harder to access for bigger deals.

“A lot of the mega-funds were able to raise $20 billion because they were anticipating doing lots of deals where they could put a billion dollars of equity in that required a lot of debt,” says Thomas Lynch, managing director at Los Angeles-based advisory firm Cliffwater. “We’re just not going to get to that level in terms of availability of leverage for a long time.”

A heightened aversion to illiquidity, he adds, is also responsible for LPs hesitating to allocate capital to the biggest funds. “We haven’t seen folks as averse to illiquidity since the 80s,” he says.

While the fundraising environment did see some improvement in 2009, some placement agents still anticipate weaker fundraising conditions through the end of 2010. “There was a distinct bump in activity in the fourth quarter of 2009 from absolutely horrific levels earlier in that year, but so far that upward momentum has not continued overall,” says DePonte. “The fundraising pace in the US and Europe in the first half of 2010 is actually off the pace for reaching the 2009 full year totals.”

Even as LP appetite for private equity increases, the fact remains that there is less capital for GPs to chase now than in the “golden days” of fundraising. “If LPs had hypothetically $100 million to invest in 2007, they probably have about $50 million today,” says Brendan Edmonds, a partner at placement agent Atlantic Pacific. Whereas in the peak years, 90 percent to 100 percent of existing investors would typically reinvest when their GPs came back to market, that figure is closer to the neighbourhood of 50 percent now, Edmonds says.

“I think the issue for the mega-funds is they need to be able to address their fund size to the true opportunity set” says Cliffwater’s Lynch, “which is different today than it was in 2006 and 2007.”