Consider that both of the following claims appear to be simultaneously true:
*Stock
markets are expensive and therefore ought to be receptive to IPOs, and yet
there are relatively few.
*Private equity funds (including venture capital) are
struggling to achieve "exits" and return meaningful capital to their increasingly-impatient investors - to such a degree they are resorting to shuffling assets into
"continuation funds" and taking on margin loans to fund distributions.
The explanation for this apparent contradiction
must lie in the fact that - high as the stock market currently is - private
equity (PE) asset valuation marks are higher still. If they weren't, they
could just IPO the assets. Realization problem solved. But if their marks are materially higher than market, an IPO will entail major write downs that will destroying their performance numbers, low-risk credentials, and carry, which they are - unsurprisingly - reluctant to do.
The idea the IPO market is closed in a raging bull market is patently absurd - the price is simply wrong. If I wanted to sell a barrel of oil at US$150/bbl now, with Brent crude currently trading at US$63/bbl, I wouldn't find many takers either. PE claims of a weak IPO market are about as credible as a poxy frontier market central bank trying to maintain an overvalued peg arguing that the foreign currency market is "illiquid" and Fx "scarce". Yes, but only at that price.
It is not difficult to see how
this problem has emerged. PE typically has to pay a 20-30% deal premium to take assets
private. They then layer on top of the assets hefty fees (which are charged,
incidentally, as a percentage of these deal-price inflated NAVs). But when it
comes time to exit, they have to sell "at market" - they can't get a
similar 20-30% exit premium. That's a lot of overhead to recover to get to something resembling a reasonable return for LPs.
In theory, PE is supposed to improve undermanaged
assets to an extent that more than offsets both the entry premium and their
hefty fees, but in reality, the industry is now so large and so overpopulated
with mediocrity that that rarely happens in practice. Once upon a time when PE
was still a boutique industry and the world was replete with cheap and
undermanaged assets after the 1970s inflationary bear market, sure. Today, not
so much.
But PE vehicles are expected by investors to deliver returns broadly comparable to listed equities, and to do so with limited drawdowns/equity risk - the "something
for nothing" promise that seduced so many investors into alternatives in the first place. Investors wanted equity-style returns, but they didn't want the attendant risks/volatility associated with those equity returns. They wanted something for nothing.
For
a long time, the alts industry proclaimed proprietary access to alchemic methods that would deliver this in-demand combination (returns without risk), but in fact achieved it through unsavory means - a combination of leveraging assets to the hilt (while passing themselves off with a straight face as offering "lower risk" alternatives); failing to take their marks during bear markets; and then being subsequently bailed out by a combination of recovering equity markets and falling interest rates. But that ruse has got harder to sustain since rates have risen post covid. Something had to give, and increasingly is.
To keep the whole return without risk charade going as higher rates have wreaked havoc with the industry's leveraged economics, the industry has had to resort to taking aggressive marks - essentially faking/exaggerating their
returns (especially by failing to mark to market during downturns to maintain
the "uncorrelated" illusion). That might optically work on
paper for a while, but it only works until you need to actually dispose of the
assets to independent third parties. Then, the assets can command only their
actual market value, not their inflated paper ones.
They could of course take
their medicine at any time - IPO the assets at market value, take the
necessary write downs, and give their long suffering LPs the distributions they want and are rightfully entitled do (just not at the hoped for IRRs). But they haven't/won't. Instead, they claim the IPO/exit
market is tough and sit on their hands, hoping they get bailed out yet again by a bull
market and the Fed. And they still might be. But if at nearly 25x earnings the S&P is still not high
enough, one has to wonder just how severe the overvaluation of PE assets must be.
LPs take notice - you are being swindled (though in expecting something for nothing, and believing leveraged equity to be lower risk than listed equity, you are far from blameless). It
is high time the whole alts complex had a thorough clean out, and it can't come
soon enough. We will probably have to wait a bit longer though.
LT3000
