Cambridge Associates: The Problem of Too Much 'Dry Powder' in Private Investments
(June 3, 2014) — Global capital for private investments is being deployed slower than it is being gathered, resulting in higher than usual dry powder and indicating investors should take care, a report by Cambridge Associates has said.
The consulting firm found that between 2008 and the end of 2013, private capital and real asset funds raised a total of $1.9 trillion, of which only 45% had been deployed by December 31, 2013. This resulted in more than $900 billion in unspent capital, net of fees.
The study compared current capital to deployment patterns of more than 3,400 funds from 1990 through 2013 and found today’s private capital was being called more slowly than historical rates over the last few vintage years. The report also noted that capital was invested “ahead of schedule, but not by much” in 2013.
While still below its peak before the financial crisis, global dry powder was also 23% or $168 billion higher than the predicted capital level of $741 billion, the report found. “Too much [dry powder] and the pressure to put capital work before it expires could amplify competition and place upward pressure on transaction values, impacting returns,” it said.
US and European private equity and global real estate contributed to more than 72% of today’s unspent capital of nearly $1 trillion. However, the figure was still more than a quarter less than its height in 2009.
“As the private investment industry continues to recover from the crisis, annual commitments are rising, although so far have yet to match the exuberance of the last zenith” of the “robust fundraising environment just prior to the global financial crisis,” the report said.
When valued by fund size, 41% of total dry powder resulted from funds between $1 billion and $5 billion while funds greater than $5 billion contributed to only 26%, according to Cambridge Associates.
These large funds were also most susceptible to rapid swellings in the markets that could ultimately influence returns, the report said. For example, if 10 funds doubled in size from $1.5 billion to $3 billion, more than $15 billion would be added to the existing dry powder. Over $75 billion could be added to undeployed capital if 10 funds jumped from $7.5 billion to $15 billion in size.
“A sudden surge in fundraising at any level, but most especially in the largest funds, could dramatically increase the [dry powder] practically overnight,” it said. “If transaction volumes or sizes do not increase commensurately to accommodate the increase funds raised, the supply and demand dynamic will suppress potential.”
Cambridge Associates advised investors to be wary of market conditions and “set a course for steadily building their programs while avoiding the market swells” in utilizing dry powder as an indicator when deciding when and where to deploy capital.
“Though current market conditions are frothy—with record-breaking distributions to limited partners underpinning rising commitments, cresting acquisition multiples, easily available credit, and robust capital markets—they will change and the best thing to do just might be to wait it out,” the report said. “A program prepared for market volatility may create openings for selectively establishing quality manager relationships for long-term portfolio benefit.”
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