Investors give private equity managers their capital with the expectation that they’ll make it grow. But today these managers are sitting on a record $963.3 billion of dry powder, as they call money that they’ve raised but have yet to invest. The size of that pile, and the fact that it keeps rising, is making everyone antsy. A little dry powder is great if managers are holding out for better deals. But a lot can make for overly itchy trigger fingers, or can start to make investors wonder if there are cheaper ways to do nothing with cash.
1. Why is there so much uninvested cash?
How much dry powder a firm has depends on both how much it’s raising and how much it’s investing. Right now, the first is up and the second is down. Investors are pouring money into private equity in search of yield, driving near-record fundraising levels and speeding up the pace of inflows. On the spending side, managers are having a harder time finding attractive deals since asset values are generally considered high. Buyout dealmaking perked up a bit in the second quarter but remained below last year’s pace.
2. Why are there so few attractive deals?
It’s a hard time to invest for even the most experienced investor. Stock markets are in a years-long bull market and hitting record highs. Asset values are generally seen as pricey on average. Some investors say that risky assets, such as junk bonds and emerging market debt, are overvalued. All of this comes amid uncertainty surrounding rising interest rates, heated geopolitics and a pervasive sense that the market could take a bad turn.
3. Is lots of dry powder a bad thing?
Some clients might think so. Investors pay private equity managers in expectation of better-than-average returns. The industry’s track record has translated into strong growth -- at the end of 2016, global assets under management totaled $2.58 trillion, according to Preqin Ltd. Having about a third sitting idle isn’t great for customers getting charged about a 2 percent fee on assets under management without much of an upside. Some managers have shifted to charging fees on invested capital only.
4. What’s good about dry powder?
It’s not being dumped into bad deals to make investments for the sake of investing. Managers argue that they’re paid to invest wisely, and if they’re not seeing good opportunities, sitting on cash is better than blowing it. Some managers are agreeing to cap their funds at levels shy of demand, preferring to run a smaller pool that matches opportunity over collecting more assets. When the markets turn, they’ll be ready to jump back in.
5. Where’s the money in the meantime?
Dry powder sits in cash and cash equivalents such as money market funds. Increasingly, investors are parking money earmarked for private equity into exchange-traded funds in an effort to eke out extra returns while they wait. The average time it takes for new commitments to start being invested has been pushed out to as long as three years, up from one year previously, according to State Street.
The Reference Shelf
- A report on dry powder by Bain & Co.
- A Financial Times column warning that piling up dry powder now might hurt future earnings.
- A Bloomberg News article on how one firm returned extra cash to investors amid a deal drought.
- A Bloomberg Prophets column said private equity is dealing with an unintended consequence of low interest rates.
- A QuickTake explainer on active versus passive investing.