First came Blackstone.
On April 21, the New York-based private equity firm reported a first-quarter economic net income of $371 million—a fraction of the record $1.62 billion it boasted a year earlier.
“This environment may be the toughest I’ve ever lived in.”It was the fourth consecutive quarter of disappointing performance for Blackstone, and a negative omen for the competitors whose first-quarter earnings announcements would follow.
On April 25, KKR reported an economic net loss of $553 million. On April 27, Carlyle Group said it earned an economic net income of just $58.2 million—a 78% drop from the year prior.
By May 5, when it came time for Apollo Global Management to announce quarterly results, its economic net loss of $73 million seemed par for the course.
“This environment… is amongst the toughest environments or maybe even the toughest I’ve ever lived in,” Apollo co-founder Josh Harris said on a conference call discussing the results.
While the numbers being reported were only for the first quarter of 2016—an admittedly short time frame, and one that KKR’s Scott Nuttall called “strange and volatile”—they were the latest in a string of disappointing results over the past year. Carlyle’s steep decline in economic profit this quarter was even considered a positive result—if only because profits declined less than analysts predicted.
Negative earnings results are certainly bad news for investors who hold direct stock in Blackstone, Apollo, or KKR. But what about investors in their underlying private equity funds? Economic net income results, after all, include unrealized gains from investments. Do economic losses for the firms mean their funds are losing as well?
“It’s just the stock market being volatile,” said Stephen Ellis, director of financial services equity research at Morningstar. “The actual long-term valuations of their portfolios haven’t really changed much.”
The so-called investment losses, Ellis explained, are largely the result of accounting methods. Private equity firms invest in privately owned companies, which are only given a definite value when they are bought and sold. For accounting purposes, private equity holdings are valued mark-to-market—meaning their worth is judged based on their public equity counterparts. In the first quarter of 2016, those public equity counterparts were all over the place.
“We’re not immune to mark-to-market in a given quarter,” said Nuttall in a conference call discussing KKR’s results.
“A lot of these firms are still outperforming the market.”That’s not to say the fund valuations are entirely without merit. In the third quarter of 2015, for example—when Blackstone, KKR, and Carlyle all reported economic net losses—State Street’s private equity index recorded a 1.37% loss for the asset class as a whole.
Though returns for the index are not yet available for more recent quarters, Ellis said private equity funds have not been performing as well as expected. “The market being volatile, fund returns are down,” he said.
Market volatility, Ellis explained, has made it difficult for private equity firms to exit investments—and, in turn, made it difficult to raise large funds, as capital isn’t being returned to limited partners. Increased regulation of leveraged lending has also made it harder for firms to get the financing necessary to close deals.
While these factors are likely to dampen performance over what Ellis called the “medium term,” they by no means signal the end of private equity outperformance.
“A lot of these firms are still outperforming the market,” he said.
Related: Private Equity Returns Waver After Three Years of Gains