Diversified alternative investment managers (IMs) are unlikely to see soaring private equity deal activity in 2017 even with record available dry powder, as they take a more cautious approach to new transactions amid elevated market valuations.
This is according to a US Diversified Alternative Investment Managers: 2016 Update report from Fitch Ratings.
Industrywide uncalled capital, or dry powder, is at near-record levels, with Fitch-rated diversified alternative IMs holding USD273.5 billion in aggregate dry powder across private equity, credit and real estate strategies as of 30 September 2016, which was up 7.5 per cent year over year.
According to Preqin, industry PE dry powder totalled USD1.48 trillion as of October 2016; up 17.3 per cent from year end 2015. Buyout dry powder was at a record high at USD541.8 billion as of October 2016, which was 12.8 per cent above the 2008 peak of USD481.1 billion.
"The diversified alternative investment manager industry is at an inflection point in the cycle as exit activity and investment activity have both declined in 2016. Fitch expects realisation activity could moderate further into 2017, while investment activity will be more heavily dependent on identifying attractive opportunities in a very competitive environment," says Meghan Neenan, senior director, Fitch Ratings.
Buyout deal value dropped 16.3 per cent in the first nine months of 2016, according to Preqin data; however, the number of deals was relatively flat, ticking up 1.7 per cent.
Excluding the USD40 billion Heinz Company and Kraft Foods Group deal announced in 2015, year-over-year comparisons suggest deal value was down just 2.6 per cent.
Since market valuations remain high, Fitch believes diversified alternative IMs are becoming more cautious on new deal activity, as evidenced by declining debt multiples in merger and acquisition transactions and a higher proportion of equity in new private equity deals.
On the exit front, private equity-backed exits fell 36.6 per cent in the first nine months of 2016, given the record amount of exits recorded in recent years and because more volatile equity markets have been less supportive of IPOs this year. As a result, Fitch believes exit activity will continue to slow in coming quarters.
Solid private equity fundraising continued in 2016 with USD256.5 billion of capital raised in the first nine months of the year; up 19.9 per cent year over year. Fund sizes have also grown, which Fitch believes supports the notion that LPs continue to consolidate more of their investment capital with larger managers.
"In general, fund launches are taking longer to close than pre-crisis which can take managers away from deal activity; however, the duration between fundraising rounds has been extended given an increase in average fund sizes," says Neenan.
"Sector specific funds continue to attract meaningful capital, with infrastructure funds representing some of the largest fund closes in 2016."
The outlook for the diversified alternative IM industry is stable, as overall issuer fundamentals are expected to remain solid, given the locked-in nature of the majority of the fee streams. Management fees could be under modest pressure for some, to the extent the deployment of dry powder is delayed by an absence of attractive investment opportunities and given the potential for further hedge fund outflows.
But Fitch expects leverage ratios to improve for most, with incremental fee-related EBITDA growth driven by cost controls, increased scale, continued fundraising, and the gradual deployment of fee-earning assets under management that earns fees on invested capital.
