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Growing dry powder weighs on US alternative investment managers, says Fitch

US alternative investment managers (IMs) continue to operate with elevated levels of uncalled investment capital, or dry powder, at a time when credit markets remain competitive and valuations are high, according to a special report by Fitch Ratings. 

'With more capital chasing fewer deals, significant fund underperformance is possible if competition drives prices up further,' says Meghan Neenan, Senior Director, Financial Institution at Fitch Ratings. 'Outsized vintage concentrations and a lack of distressed investing opportunities, a traditional area of investment for alternative IMs, could potentially exacerbate this issue.'
 
Dry powder for the firms in Fitch's review totalled USD254.4 billion as of 30 September, 2015, representing a 35.2 per cent increase from a year earlier.
 
That said, income from exits has doubled for the top six IMs over the last three years. Alternative IMs are continuing to take advantage of market valuations by exiting investments for strong returns. Gross realised incentive income amounted to nearly USD8 billion for the top six firms in the rated universe for the 12 months ended 30 September, 2015. This compares to USD4 billion of gross realised incentive income earned in 2012. 
 
Additionally, dislocations in the commodity markets, given declines in crude oil prices, are expected to provide investment opportunities for alternative IMs, which have long-term capital in place to capitalise on market cycles. As of 26 August, 2015, approximately USD32 billion of capital had been raised for dedicated natural resources funds in 2015, according to Preqin, which is already higher than the prior peak of USD30 billion, reached in 2013. Fitch believes these numbers understate the true investment capacity in the sector, as many of the largest alternative IMs' buyout funds invest in energy deals alongside their natural resources funds or on their own. Fitch is mindful of the risk of over-extending into energy and natural resources investments at the wrong time, as there is continued uncertainty around how long downward pressures will remain on certain commodity prices. 
 
Fitch affirmed the ratings for all seven rated alternative IMs on 5 November, 2015, reflecting strong management teams and franchises, globally diverse product platforms, relatively stable core operating fundamentals due to the locked-in nature of a large portion of fee revenue; continued growth in fee-earning assets under management (AUM); modest but moderately increasing leverage levels; manageable near term obligations relative to available liquidity resources; and increasing diversity of AUM.
 
Still, Fitch did revise the Rating Outlook for The Carlyle Group to Negative from Stable due to a lack of progress on core fee-related earnings before interest, taxes, depreciation, and amortisation growth, given a continuation of high fundraising costs, elevated 'catch-up' management fees, and hedge fund redemptions, which have prevented the firm from reducing its elevated leverage ratio. 

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