Diversified alternative investment managers (IMs) appear to be taking a cautious approach to the transaction structures of new business originations, as elevated valuation multiples led to a decline in buyouts in 2016, according to Fitch Ratings.
Private-equity backed buyout deals dropped 16.2 per cent in the first three quarters of 2016, according to Preqin, compared to the comparable period a year ago.
But average debt multiples on executed buyout deals have been trending down, amounting to 4.7x in 3Q16, compared with 5.0x a year ago and 5.8x in 2Q14, according to PitchBook data.
Additionally, the median percentage of debt used for US M&A activity dropped to 48.4 per cent as of Q3 2016, compared with 55.9 per cent in 2015. These trends indicate that alternative IMs are maintaining underwriting discipline in Fitch's view.
"Given the current competitive deal environment, Fitch is cautious about alternative investment managers' ability to deploy capital and invest, particularly as they sit on near-record amounts of dry powder," says Meghan Neenan, senior director, Fitch Ratings.
At 30 September 2016, Fitch-rated alternative IMs had aggregate dry powder of USD273.5 billion; up 7.5 per cent from the prior year.
Despite the challenging investment conditions, Fitch has a stable ratings outlook on the sector, given the locked-in nature of the majority of alternative IMs' 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 outflows in hedge funds. But Fitch expects leverage to improve for most, with incremental FEBITDA growth driven by cost controls, increased scale, continued fundraising, and the gradual deployment of capital.
