How Private Equity Lost Its Mojo

0:00So there's a lot of noise about AI, but time's too tight for more promises. So let's talk about results. At IBM, we work with our employees to integrate technology right into the systems they need. Now, a global workforce of 300 ,000 can use AI to fill their HR questions, resolving 94 % of common questions. Not noise. Proof of how we can help companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business. IBM. Support for the show comes from public.com. If you're actively involved in your portfolio, you probably catch yourself repeating the same actions.

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2:22Allison McNeely:Bloomberg Audio Studios. Podcasts. Radio. News. When the Fed makes it a little bit easier to borrow money by lowering the cost of borrowing money, that is sort of a positive vibes move. The Fed lowered interest rates last week. So that's welcome news for people who are looking to borrow money, whether it's for a mortgage. But that positive vibes move for borrowers came with a warning that the job market is weakening and inflation is still elevated. And now everyone's eagerly awaiting the Fed's next steps. Most officials forecast the Fed will use those meetings to lower interest rates by another half a percentage point.

3:05Allison McNeely:The Fed will keep lowering rates in order to prop up the slowing job market. Which would be particularly good news for one corner of the finance world. Private equity. When it is cheaper to borrow money, you can borrow more money and therefore do larger and larger deals. And as the deals get bigger, the funds get bigger. As the funds get bigger, the profits get bigger. As the profit gets bigger, the firm grows. And pension funds make money, ideally. The people working at the private equity firms make money. And it sort of becomes this, like, ever-expanding asset class. That's Alison McNeely, who covers the private equity industry for Bloomberg.

3:47Private equity firms thrive off buying, flipping and selling companies for a profit. And Alison says there's a reason they've been hungry for lower rates. After a half century of meteoric growth, the industry has found itself in a historic slump. But while the recent rate cut could encourage more dealmaking, private equity's issues are much larger than what one Fed decision could turn around. What's going wrong with P.E. is they are having a hard time selling assets, returning capital to investors, raising more money. It's been harder to sell companies and make profits for investors and harder to raise new money from those investors and sort of keep the flywheel going of business.

4:31Private equity firms across the board are struggling to cash out of old investments, raise new funds, and most of all, produce the kinds of returns that their investors have come to expect. And Allison says privately, many institutional investors in PE are tempering their investment expectations for the next decade. When the private equity sort of fly machine is working properly, you're constantly raising new money in funds, putting that money to work, investing in new companies, selling companies, ideally at a profit that they've held for a long time. And you've got a sort of a constant churn of money coming in and out of the funds, being returned to investors and allowing the firm to grow.

5:15So that churn is what's grinding to a halt. Exactly.

5:22I'm Sarah Holder, and this is The Big Take from Bloomberg News. Today on the show, private equity at a crossroads. Why PE firms are struggling to buy, sell, and fundraise the way they did in their heyday, and what that could mean for the industry's future.

5:44Proponents of private equity and people who believe in investing in it will tell you that it's a great asset class because it beats the stock market. If you want to make a lot of money, you should invest in private companies because there is basically more juice to squeeze than investing in, say, a publicly traded stock or bond for that matter. And so they will just say there's higher risk, but also higher reward. People who are skeptical of private equity will tell you it's a very expensive asset class. Fees are higher than, say, the fee that you would have to pay to buy a public stock in your brokerage account.

6:19So the private equity firm takes a bigger cut through higher fees and that they maybe don't produce as good or as strong of results as they say that they do. And there's an ongoing debate about how the industry measures success. As the industry has slowed down in the last couple of years, people have sort of shifted their focus to DPI or distributions to paid in capital. It is basically saying, if I give you a dollar, are you giving me a dollar back? Are you giving me a dollar fifty? Are you giving me two dollars? Or if I give you a dollar, are you giving me five cents back? I don't want five cents back.

6:58I want like at least a dollar, preferably two dollars. And so as more private equity firms have struggled to reach that two or three dollar return, people are asking more questions about what the value is of private equity. The private equity industry peaked in the second quarter of 2021, when quarterly returns for U.S. firms hit around 13.5 percent, according to PitchBook. But then came 2022. That is when the U.S. Federal Reserve raised interest rates. And that was bad news for an industry that runs on debt. Firms have the companies that they acquire borrow money to facilitate deals buying and selling.

7:40And so when you make debt more expensive by raising borrowing costs, which is what the Federal Reserve did in 2022, that makes it less attractive to do deals. And when it's less attractive to do deals, that means people aren't buying and selling as many companies and they are not generating profits for their institutional investors. And so what happens is you get a sort of a chicken and an egg problem where if you're not selling assets or selling companies and returning money to investors, they're in turn going to have less money to give you for future deals. Everything kind of grinds to a halt.

8:16The frenzied era for private equity was over. Last year's fourth quarter saw U.S. PE firms report returns of just 0.8 percent. When Donald Trump took office in January, P.E. firms were optimistic that the new administration could help them turn things around. The president was perceived and is perceived as being pro-business and creating a good environment for doing deals, potentially less regulation, less antitrust enforcement. But according to Allison, a lot of P.E. firms say Trump's tariff policies have made their jobs harder. People in the industry refer constantly to Liberation Day as being the moment when things might have changed.

9:00There is a lot more mixed feelings, I would say, among people in the private equity industry about the current administration, a lot of uncertainty around tariffs and the general policy stance on some of these key issues. That uncertainty and the threat that tariffs would reignite inflation held the Fed back from lowering interest rates for months, even as Trump pushed for aggressive cuts. And while last week's quarter point adjustment could help P.E. firms borrow from the bank, the current economic environment is also making it harder for them to raise money from investors. When private equity firms go out to raise a new pool of capital, they generally have a target.

9:42They tell their pensions and their endowments, we plan to raise, you know,$10 billion. And hitting that target is an important signal to the market that there is confidence in this firm, there's confidence in the strategy, and that they are growing. Allison looked at one firm in particular that's experienced the recent fundraising slump firsthand, Insight Partners. Insight Partners invests in venture capital and private equity with a focus on technology, a very attractive, high-growth space, really one of the hottest areas of private markets investing. When they went out to raise their most recent flagship fund, they indicated to the market that they were looking to gather about$20 billion, which is the same as their prior fund.

10:30Is that a lot for a raise? That is a lot. That is a lot. That is a big fund. Insight Partners put a lot of money to work. They invested really during the heydays of investing in technology and software when a lot of deals were getting done at really high valuations. And after interest rates went up, the deal making environment really changed. You know, they really said to LPs and private conversations, hey, we realize that we put a lot of money to work really quickly. The market was really kind of hot and busy and we were out there with a lot of other folks doing a lot of deals. But we're really focusing on distributions and we're really focusing on returning capital to you, our investor base.

11:10However, that message didn't entirely resonate because Insight Partners ended up closing their fund earlier this year with around$11.5 billion. So less than$20 billion. Yes, less than$20 billion. And that was after they revised the target down previously, recognizing that maybe the landscape had changed. and things were not as attractive for investing as they had been previously. And Insight Partners is hardly alone in having maybe not met their initial expectations for how much money they would raise. This has been a problem that has impacted many firms across the industry. How is this challenging moment for PE sitting with limited partners?

11:57Are they getting frustrated? It's really interesting. Limited partners, so the pension funds, the endowments, traditional institutional investors and private equity, will say sort of privately that they're very frustrated. But they're hesitant to speak out publicly because, in their view, private equity has been a good asset class to invest in for decades. And they have done well by allocating money towards it. But also a sense at this point that they want to kind of wait and see. And if the conditions for doing deals improve, maybe we're just going to go through a bit of a bumpy patch and things will get better.

12:39So just how are private equity firms adapting to this moment? And will their strategies be enough to turn the industry around? That's after the break.

12:58repeating the same actions, buying the dip, manually sweeping idle cash, putting on a hedge. On public, you can now create AI agents that handle all these tasks on your behalf. Just describe what you want to do in plain English, like if the VIX hits 25, buy a put option on the S &P 500. Or if my cash balance goes above$20 ,000, move the excess into my direct index. You approve of the workflow and your agent handles the rest. Monitoring the market, watching for your conditions, and executing your strategies exactly as defined. An investing platform driven by your intent, not just your clicks. You can also get full read and write access to your account via the public API.

13:41Go to public.com slash market and fund your account in five minutes or less. That's public.com slash market.

13:48Allison McNeely:Paid for by Public Investing. Brokered services by Open to the Public Investing, Inc., member FINRA and SIPC. Advisory services by Public Advisors, LLC, SEC registered advisor. Complete disclosures available at public.com slash disclosures. So there's a lot of noise about AI, but time's too tight for more promises. So let's talk about results. At IBM, we work with our employees to integrate technology right into the systems they need. Now, a global workforce of 300 ,000 can use AI to fill their HR questions, resolving 94 % of common questions. Not noise, proof of how We can help companies get smarter by putting AI where it actually pays off, deep in the work that moves the business.

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15:11Technology designed to help doctors spend less time on busy work and more time with their patients. And those prescriptions? Optum is working to bring costs down, save patients money, and make it easier to get refills. Little by little, Optum is helping make healthcare work as one for everyone. Head to business.optum.com to see how.

15:36The struggle is real for private equity firms and for the institutional investors who've given them money. PE firms are reporting lower quarterly returns and sitting on mountains of cash they haven't yet deployed. According to an estimate from the management consulting firm Bain, the industry was holding about$1.2 trillion for potential dealmaking as of mid-year. Bloomberg's Alison McNeely says some firms are leaning on new tactics to get back on track. There's sort of an emerging, it's not even emerging at this point, It's a fast-growing, robust area of private markets called secondaries. When a private equity firm goes out and buys a company, does a deal, that's called a primary investment.

16:21So they raise a fund. It's going to be in business for 10 to 12 years. They're going to buy and sell deals out of that fund during the time. And then they're going to ideally, like, wind it down, sell everything off, and move on to the next fund. And that essentially means raising a new fund that has the express purpose of buying that existing investment out of the old fund, resetting the clock on it, bringing in new money to back it up and buying themselves more time. So they're selling a company to themselves and they're buying that company. They are effectively selling a company to themselves out of an older fund into a newer fund and then simultaneously with the newer fund bringing in new investors.

17:02So does that mean the investors in the old fund get paid out at that point? They can if they want to. And so they say, we recognize this investment's getting a little long in the tooth. We should be, you know, selling it by now. We've brought in these new investors to cash you out if you want to be cashed out. But then also some investors are like, no, I believe in you. I like this asset. I'm comfortable rolling over into the new fund and like sticking around for the ride. So this is something that private equity firms have done for a long time, but it's becoming more common in this kind of dealmaking environment?

17:33Yeah. These transactions, they have grown very quickly in the past couple of years as sort of an alternative. Because traditionally, a private equity firm will sell a company by selling it to another private equity firm, by selling it to another company or IPO-ing it, listing it on the stock market. Those paths have been more difficult. And so essentially selling the asset to itself and other investors in these fund transactions is another way to kick the can, get some cash and kind of preserve optionality for the potential rebound of the deal market in the future. Does that raise any alarm bells?

18:10Yeah, there are some people who don't like them because these transactions, which they're called continuation funds. Don't worry about it. Very jargony. But people don't like these funds because there's an inherent conflict when the same party is both the buyer and seller. Proponents of the deals will say, well, that's why we bring in new investors. They validate the price, they validate the value of the asset, and they basically make sure the transaction's on the up and up. Meanwhile, the industry is also looking at other ways to bring in more capital, like getting private equity investments included in retirement portfolios.

18:46portfolios. Allison, in August, Trump signed this executive order that's supposed to pave the way for private equity to enter into 401ks, something we've talked about on the show before. What is the status of that push right now and what kinds of implications could it have for the industry and for people with a 401k? The 401k executive order and just broadly the signaling of the current administration that they are open to private assets being in the hands of individual investors Like, this is the most exciting thing for the industry ever. It is potentially billions, if not a trillion at some point, of dollars of new money.

19:30So the 401k market defined contribution plans are about$12.5 trillion in assets under management. They're almost entirely invested in stocks and bonds. If you can carve off even a sliver of that, you open up a massive new pool of money that can come in and start investing in private equity funds. At a time when private equity firms have struggled to raise capital from their traditional investor base, the potential for, you know, regular people, you and me and anyone else with a 401k plan to start investing in these funds as well, opens up a really significant pool of money at a time when it is really needed by these firms.

20:13Allison says some of the PE experts she's talking to see this as a pivot moment for the industry. There are people in the industry who very much think that private equity needs to get back to its roots of buying and selling companies at multiple times what they paid for them and making big bets and getting slam dunks. There are also people who will say, you know, these secondary transactions, the 401k money, all of this is actually just reflective of the growth and the maturation of private equity and private markets investing more broadly. That even if the deal market comes back in a meaningful way, all these sort of newer developments are here to stay and are just part of the range of options that firms have for how they raise capital and how they manage their investments.

21:11Could this moment lead to any broader soul searching at these PE firms about how they might build back differently moving forward? I think the soul searching that has occurred at private equity firms over the past couple of years has really been around distributions and potentially also the pace of growth. And I think in some corners of private equity, there are some soul searching happening that, you know, maybe$20 billion for a fund is big enough. Maybe we don't need 25. Maybe we don't need$30 billion. Maybe 11 is enough. Maybe 11 is enough because if we have a smaller pool of capital, we can focus on doing the right deals, being strategic and not trying to be so big.

21:59Yeah, maybe it's a reset of expectations that boundless growth doesn't always have to be the goal. Just strategic growth, focusing on your knitting, focusing at the end of the day on buying and selling good companies and making returns for your investors.

22:37If you liked this episode, make sure to follow and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.

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