Is there a bubble developing in the private capital market?

Perhaps most family offices already know this, and if they do, this article will just confirm their fears. But there looks to be a bubble growing fast in the world of private capital investing and it could go the same way as the hedge fund industry did after the financial crisis, i.e. lose favour fast.

Evidence from a recent report from Preqin, the alternative asset data group, shows just how fast the private capital market has grown since 2007. In 2016, the number of private capital firms grew by 872, according to Preqin. That compares with an average of only 220 a year from 1980 to 2015. And there are now 7,129 such firms – that’s a lot of mouths to feed.  

The big growth in their numbers since 2016 is being driven by excellent returns in the private equity market. Over the five years to the end of 2016 private equity funds have generated a median net annualized return of 11.4%, that compares to 5.2% for hedge funds, and 9.1% for listed equity, says Preqin. And the net capital flow to investors has increased rapidly since 2013. These flows, which measure the difference between distribution returned from private capital funds to their investors and total capital calls, reached a record $402 billion in 2016, compared with $121 billion in 2013.

Some analysts are beginning to see a familiar trend developing in the private capital/equity world – the growth of a bubble. Here’s what one Bloomberg columnist called Nir Kaissar said earlier this week:

“Like hedge funds before them, there’s little chance that 7,000-plus private capital firms will on average continue to deliver the highflying returns that investors see in the rear-view mirror. The trillions of dollars now chasing private assets have driven up private equity valuations, slashed private debt yields and compressed capitalization rates for private real estate. None of those things bode well for future returns.”

He added: “Investors’ love affair with private assets may be just beginning. But if the hedge fund debacle is any guide, it won’t end happily.”

Food for thought, at the very least…