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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 percent.
It 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 us like ever expanding as a class.
That's Alison McNeely, who covers the private equity industry for Bloomberg. Private equity firms thrive off buying, flipping, and selling companies for a profit, and Allison 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 deal making, private equities issues are much larger than what one FED decision could turn around.
What's going wrong with PE 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.
Private 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 in 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.
So that churn is what's grinding to a halt.
Exactly.
I'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 and they're hated, and what that could mean for the industry's future.
Proponents 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 and 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. 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. I want at least
a dollar, preferably two dollars. And so as more private equity firms have struggled to reach that two or three dollars return, people are asking more questions about what the value is of private equity.
The private equity industry peaked in the second quarter of twenty twenty one, when quarterly returns for you US firms hit around thirteen point five percent according to Pitchbook, But then came twenty twenty two.
That is when the US Federal Reserved 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. And so when you make debt more expensive by raising boring costs, which is what the Federal Reserve did in twenty twenty two, 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.
The frenzied era for private equity was over. Last year's fourth quarter saw USPE firms report returns of just zero point eight percent. When Donald Trump took office in January, PE 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 anti trust enforcement.
But according to Allison, a lot of PE 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. There 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 PE 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. They tell their pensions and their endowments. We plan to raise ten billion dollars, 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 invest 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 together about twenty billion dollars, which is the same as their prior fund.
Is that a lot for that is a lot.
That is a lot. That is a big fund. Inside 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 realized 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. However, that message didn't entirely resonate, because Inside Partners ended up closing their fund earlier this year with around eleven point five billion.
Dollars, so less than twenty billion, Yes.
Less than twenty 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 Inside 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? Are they getting frustrated?
It's really interesting limited partners, so the pension funds, the endowments, you know, traditional institutional investors in 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.
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.
So 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. The struggle is real for private equity firms and for the institutional investors who've given them money. The efirms 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 Vein, the industry was holding about one point two trillion dollars
for potential deal making as of midyear. Bloomberg's Allison 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. So they raise a fund it's going to be in business for ten to twelve 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're 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.
So 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 investments 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 deal making environment.
Yeah, 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 ipoing 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?
Yeah, 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 that transactions 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. Allison. In August, Trump signed this executive order that's supposed to pave the way for private equity to enter into four oh one K's 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 four oh one K.
The four oh one K 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. So the four to on K market to find contribution plans are about twelve point five trillion dollars 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 four one K 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.
Allison 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 four one K 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.
Could 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 twenty billion dollars for a fund is big enough. Maybe we don't need twenty five. Maybe we don't need thirty billion dollars.
Maybe eleven is enough.
Maybe eleven 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.
Yeah. 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.
This is the big take from Bloomberg News. I'm Sarah Holder to get more from The Big Take and unlimited access to all of bloomberg dot Com. Subscribe today at Bloomberg dot com slash podcast offer. If 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