Of all global private capital in 2019, 32% was invested into buyout funds.1

Buyout funds leading private market assets allocated to alternative investment funds, H1 2019

Sources: Preqin, cited from McKinsey & Company, McKinsey Global Private Markets Review 2020
Note: Figures are rounded to nearest million

Learn more inside our white paper about how buyout funds create value, looking at three key areas:

1   Bain & Company, Global Private Equity Report 2020: Buyout funds include Private Equity, Real Estate, Infrastructure and Natural Resources

Let us take a deeper look into what each point entails.

Three factors explain the steady and sustained movement of capital into the private markets and the emergence of private equity into the mainstream.

1. Addressable market: The opportunity set is much greater – private companies represent 10x more market cap than publicly listed ones. Additionally, the number of publicly listed companies in the US has declined by 50% since 1996.3

2. Outperformance: Private equity has maintained a consistent record of outperformance: according to a study by JPMorgan Asset Management, private equity generated 14.4% net annual returns between 2003-17, compared to 8.8% from the MSCI World equity index. Since 2000, the net asset value of private equity companies has grown more than 8x, compared to 2.8x for publicly quoted companies.4

3. Institutions: Institutional investors have been increasing their allocations to private equity, with 52% of endowments and 28% of pension funds now invested in the asset class. In turn, the number of private equity managers has increased, with private equity firms growing in number by 143% between 2000-2014.

Global private capital, AuM 2010-2019, in US $trn

*At June 2019
Source: Preqin

Exposure to Private Markets investments of different investor classes, % of total

Sources: Willis Towers Watson, “Global Pension Assets Study“, 2019; National Association of College and University Business Officers, “TIAA Study of Endowments”, 2018; Money Management Institute, “Retail Distribution of Alternative Investments“, 2017. Averages provided are dollar-weighted. Cited from Blackstone Group Seeking an Alternative: Understanding and Allocating to Alternative Investments

continue to the next chapter

Value creation in buyout funds

The historic outperformance of buyout funds is no accident. It derives directly from the ability of fund managers to add value to the companies they invest in, generating returns through an active approach to investment and management.

Unlike investors in public equities, who must trust in a target company’s ability to create value without intervention, most buyout funds actively manage their investments. A fund’s general partner (GP) and team will work closely with each portfolio company’s management to improve its efficiency, performance and valuation multiple.

The evidence bears out the value created by this active approach. An analysis by the Moonfare investment team of five completed funds selected for their success found that 72% of the incremental value created from investment to exit could be attributed to operational changes that resulted in revenue and EBITDA growth.

In this section we look at four main drivers of this value creation: management effectiveness, operational support, access to finance and multiple expansion (Figure 2).

Figure 2: Active Manager Interventions and Financial Value Impact
The leading buyout funds have developed platforms and playbooks to consistently create value for their investments Illustrative Financial Value Impact (sample of five leading buyout funds assessed by Moonfare due diligence)

Source: Performance attribution of all exits for 5 complete funds of recent Moonfare GP due diligence

Value creation in global buyout platforms
Active Manager Intervention

1. Step-change the effectiveness of a firm’s management

  • Superior governance model
  • Equity incentive to turn managers into owners
  • Talent upgrade

2. Increase top-line growth and margins through operational support

  • Process and systems improvements
  • Expand sales & marketing effectiveness
  • Global network produces synergies

3. Support strategic changes by providing direction and capital market access

  • M&A to consolidate fragmented markets
  • Anti-cyclical investments using funds’ capital access
  • Increase capital efficiency

4. Non-Operational Factors

  • Deleverage
  • Multiple Expansion

continue to the next chapter

Investing in buyout funds

A recent Bloomberg Law analysis shows that despite the financial difficulties generated by the Covid-19 crisis, private equity M&A market share and buyout volumes remain solid. In the US alone, there is $101.3bn in proposed, pending, and completed private equity buyouts in 2020, a 15% rise from 2019.

For those who have not previously invested in private equity, there are some important considerations to bear in mind:

1. Cashflow

  • Illiquidity – unlike in public markets, there is no regular trading of shares, this illiquidity premium is the foundation of private equity.
  • Capital commitments – investors typically commit their capital to a fund over its decade-long lifetime, with capital calls spread out over the first few years.
  • Distributions: Funds make distributions progressively as assets are sold, the typical holding period for an asset being 3-5 years.

This leads to a ‘J’ curve of cash flow, as Figure 5 illustrates.

Figure 5: The expected cash life-cycle of a private equity fund

Source: Moonfare
Note: For demonstration purposes only. Private equity investments are inherently risky

Essentially, investors are engaging in a trade-off: lower liquidity in return for the potential of higher returns, creating the time needed for managers to make the strategic and operational changes that generate value.

2. Role in portfolio
Data from at least the last three decades shows that private equity has provided investors with the highest risk-adjusted returns as an asset class. private equity offered the highest annualized returns among the major asset classes while exhibiting less volatility than listed equities, even when desmoothing private equity returns (Figure 6).

Figure 6: Asset Classes Risk Return Chart

Source: McVey, H., H. (2018). Rethinking Asset Allocation (Rep.). New York: KKR Global Institute
Data as at 1Q86 or earliest available to 4Q17, and de-emphasizing 2008 and 2009 returns at one third the weight, due to the extreme volatility and wide range of performance which skewed results

3. Buyout as a private equity investment strategy

Large cap buyout funds offer new private market investors a vehicle to access the benefit of strong underlying assets stewarded by effective, experienced managers. The investment strategy targets the technology sector, which has generated the strongest returns for investors between 2010 and 2018.

Technology deals, especially software buyouts, have produced stronger returns than the private equity market overall
Pooled MOIC10 for fully realized buyout deals, 2010–18

Source: McVey, H., H. (2018). Rethinking Asset Allocation (Rep.). New York: KKR Global Institute
Data as at 1Q86 or earliest available to 4Q17, and de-emphasizing 2008 and 2009 returns at one third the weight, due to the extreme volatility and wide range of performance which skewed results

Existing investors in the asset-class may want to consider if they are sufficiently diversified, both across the different fund types (from buyout to private debt and real assets), and in terms of the underlying assets. Accessing the full range of opportunities afforded by private equity requires diversification even within the asset class.

Moonfare provides unique access to top buyout funds.

With Moonfare’s access to top buyout funds, qualified investors have the unique chance to invest in this exclusive and attractive asset class. Current investment opportunities are on a first-come, first-served basis and not all allocation requests may be met.

Moonfare opens up the world of Private Markets to qualified professional investors like never before.

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