A flattening yield curve—the Boogeyman of Wall Street—sends shockwaves through the investor community, and private equity fundraisers are not immune to it either. Currently at only 0.16 percentage points wide—hovering around its trough since the Great Recession—many analysts are predicting the curve’s inversion as soon as in 2019.
Harbinger of Recession
An inverted yield curve has been an astonishingly good predictor of recessions in the past. According to San Francisco Federal Reserve Bank, an inverted yield curve has preceded each of the past nine recessions, dating back to 1955. The inversion implies that the interest rates on two-year Treasury notes are higher than those on 10-year notes, as investors’ expectations for long-term economic growth vanish.
The recent U.S. stock market selloff, whether it is a correction or the beginning of a bear market, is another indicator of Wall Street’s cautious sentiment. Research conducted by buyout pioneer KKR further supports this outlook. Based on the firm’s projections, the risk of recession from late 2019 onwards increases materially.
In this environment, many private equity firms are beginning to reevaluate their fundraising options.
Old Habits Die Hard
For firms inclined to an old-fashioned approach, we can expect to see them rush to traditional limited partners—such as endowments, pension plans, and insurance companies—to secure long-term capital before the storm hits.
In his recent interview for Bloomberg, Jonathan Gray C92 W92, president and COO of Blackstone, said that his firm is currently sitting on a nearly $100 billion pile of “dry powder”. Not all buyout firms, however, have the luxury of locked-in capital that can be deployed when asset prices drop sharply.
Raising new funding during a recession is hard, and industry data supports this notion. Global private equity fundraising peaked in 2008, reaching $674 billion before it tanked more than twofold to $315 billion a year later, when the Great Recession hit.
The health of the public securities markets plays a major role in fundraising. Deteriorating prices for stocks and bonds unbalance asset allocations for limited partners–who typically dedicate only a fraction of their portfolio to buyout firms–and force them to reduce exposure to private equity asset classes.
Furthermore, in the down times, institutional investors prefer to channel capital to a chosen few buyout shops that delivered the best performance before, making it even more challenging for smaller and emerging fund managers to get traction.
Public Markets: To Go or Not to Go?
Tapping into public markets in a quest for capital may be another option, but while some large private equity players—such as Blackstone, KKR, The Carlyle Group, and Apollo Global Management—enjoy their publicly-traded status, going public for smaller firms is prohibitively costly and requires compliance with stringent disclosure requirements.
Besides, in current volatile environment going public may be a kiss of death. Correctly pricing an IPO is next to impossible when the stock market is a roller coaster.
May the Force of Technology Be with You
As a result, many private equity firms are increasingly turning to technology in search of fresh funds.
Technology is a modern-day blessing and a curse. With artificial intelligence evolving at a rapid pace, we may soon find ourselves in a post—apocalyptic world of “The Terminator”—at least, as Elon Musk C97 W97 puts it.
While mutual fund managers are using artificial intelligence in picking stock, private equity investors are only beginning to exploit its merits in their investment decision-making, not to mention fundraising.
The same cannot be said about fintech. Fundraising platforms, such as iCapital Network, DealMarket, and Delio provide access to deep pockets of individual accredited investors, wealth managers, and family offices—all hunting for high-return deals.
This market segment remains relatively untapped, as opposed to a menu of traditional private equity limited partners. Besides, it has more discretion over portfolio asset allocations, and is therefore less susceptible to stock market volatility.
As the yield curve continues to flatten, threatening to invert this year, private equity investors should reevaluate their fundraising game plan going forward. With IPO markets remaining largely closed, and traditional limited partners becoming increasingly cautious about asset allocations and emerging fund managers, fintech fundraising platforms appear in a good light, as they provide access to an untouched pool of investors who are yearning for high returns that private equity can deliver.
The major issue here is the management of a larger stakeholder base. Nevertheless, what wouldn’t a private equity financier do to reap that carried interest in the end?