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exceptional year
McKinsey Global Private Markets Review
February 2017
Private Equity and Principal
Investors Practice
A routinely exceptional year
In 2016, the most exciting news for private markets around Brexit and in the United States around tax,
may have been what didnt change. In these trade, and infrastructure, and sectors such
marketsmainly private equity but also closed-end as healthcare, energy, defense, and industrials.
funds for real estate, infrastructure, natural While these unknowns will create opportunity
resources, and private debtinvestors desire to for some, most GPs acknowledge that this
allocate remains strong. Whether measured sort of uncertainty is very difficult to price. As one
by fundraising (firms received $625 billion of new CEO said, Some of these changes in the US
capital in 2016) or assets under management will raise the base case for GPs, but the tails are
(AUM), now $4.7 trillion worldwide, private markets very fat.
in 2016 continued an impressive cycle of expan-
sion that began in 2008. The industry continues to Most agree that public markets, despite their
provide a source of excess capital for investors; recent run-up, are becoming structurally less
in 2016, distributions outstripped capital calls for attractive to many limited partners (LPs), who will
the fourth year running. New entrants continue likely respond by further raising their alloca-
to flock to the industry, and the number of active tions to private markets. Creativity in fees and
firms is at an all-time high. (For more on products will flourish, producing a range of
the scope of our research, see sidebar, Private options: we will still see full-service GPs offering
markets, defined.) closed-end funds, of course, but also more LPs
in co-investments, more separate accounts, and at
While growth in fundraising, AUM, and capital least a few more LPs investing directly. Finally,
distributions to investors are trends to celebrate, most executives believe emerging markets will
growth also presents challenges. The larger normalize following the recent period of turbulence
number of general partners (GPs) reflects the and will start to more closely resemble the industry
industrys success but also heralds increased in developed markets.
competition, which has contributed to rising deal
multiples. As GPs have grown gun-shy about About this report
todays higher prices, deal activity has fallen, and To produce this report, we have developed new
dry powder has reached an all-time high analyses drawn from our long-running research on
though our research suggests that dry powder is private markets, based on the industrys leading
not nearly the problem that some have suggested. sources of data.1 We have also conducted interviews
In fact, in this and other ways, the industry is with executives at some of the worlds largest and
overcoming its growing pains and finding new most influential GPs and LPs. Finally, we have
ways to deliver for its investors. gathered insights from our colleagues around the
world who work closely with asset owners
Discussions with industry leaders reveal several and managers.
common themes about what to expect in 2017. All
acknowledge an extraordinary number of wild This report begins with a review of the industrys
cards in play, in geopolitics above all, particularly capital flows in 2016. Next, we discuss the
Liability gap
Funded ratio, CAGR,5
2015 2016 2016, % 201516, %
1,832 1,879
State and
3,664 3,818 67 3
local2
1,822 1,890
Federal3 44 4
1,512 1,515
497 507
1 Federal Reserve estimates US pension assets as comprising federal government retirement funds, state and local government employee
private equity firm remarked, With pressure on tained low-return environment in public markets
commodity prices, SWFs are going to be in over the next 20 years (Exhibit 2). In a slow-growth
the same position as US pension funds. They are scenario, US equity returns may fall by as much
allocated 5 or 6 percent to private equity now as 390 basis points, and fixed-income returns by as
and will go to 10 or 11 percent. Interest in private much as 590 basis points. In a growth recovery
market investing among high-net-worth scenario, US equity returns could fall as much as
individuals is also increasing, leading GPs to 240 basis points, and fixed-income returns
launch new products for retail high-net- by 490 basis points.
worth investors.
In the face of these subdued returns, LPs will
LPs continued interest in private markets is also a continue to look to private markets based on their
function of their anxiety about the outlook for belief in these markets outperformance relative
public markets. As the McKinsey Global Institute to public markets. This confidence is reinforced by
has concluded,2 LPs face the prospect of a sus- the positive cash flow private markets have
Exhibit 2 In two growth scenarios, returns over the next 20 years would be substantially
lower than in the 19852014 period.
1985 Slow Growth 1985 Slow Growth 1985 Slow Growth 1985 Slow Growth
2014 growth recovery 2014 growth recovery 2014 growth recovery 2014 growth recovery
Global Returns database, which targets a bond duration of 20 years. Future returns show ranges across a set of countries and are based
on 10-year bonds.
Source: McKinsey Global Institute analysis
600
35
300
0 0
200
400 35
600
Capital called
800 70
2000 2004 2008 2012 1st half
of 2016
500
400
200
Source: Preqin
4,000
3,000
2,000
1,000
Real estate 12.6 3.2
Private debt 10.9 14.6
Natural resources 15.9 25.7
Infrastructure 15.1 32.3
0
2000 2004 2008 2012 1st half
of 2016
Source: Preqin
Exhibit 6 Assets under management in private markets now total $4.7 trillion.
328
34 97 393
North
827 294 446
America
172
89
Private equity
Source: Preqin
Collectively, then, capital inflows to private growth over the previous five years. Driven by
markets showed solid growth in 2016. A closer look lower fees and greater visibility into fund
at the major asset classes reveals some interest- performance, growth in secondaries fundraising
ing dynamics. reflects the industrys maturation, as private equity
has become more liquid and less private.
Private equity. As ever, private equity (driven
principally by buyouts) is the largest asset class in In 2016, private equity fundraising growth was
committed capital over time.4 At 9.7 percent growth also propelled by funds focused on Europe,
from 2015 to 2016, it accounts for much of the which grew by 42 percent year on year, following a
growth in private markets. Buyout funds raised slight decline the previous year. A primary driver
more than $210 billion in 2016, a 33 percent of these gains was the introduction of several large
increase over 2015, following two years of decline. funds raised in 2016 by leading European
Secondary funds grew 26 percent last year, firms. Funds focusing primarily on North America
a marked increase from 14 percent per annum demonstrated much slower growth in 2016, at
In North America and Europe (which grew at The experience of closed-end private debt
87 and 64 percent, respectively), infrastructure funds also varies by region. In Europe and North
fundraising has now surpassed pre-crisis America, despite lower fundraising in 2016,
levels. Asia also saw a modest increase (19 percent), interest in this asset class has remained strong over
while the rest of the world fell dramatically the past five years, as traditional private equity
by 80 percent. One factor that may explain these GPs expand their business model. In Europe
changes is the degree to which infrastructure (particularly Germany), demand for private debt
growth in emerging markets has been driven by has risen because stricter regulation and
greenfield deals. Recently, emerging-market capital requirements have constrained banks
greenfield projects have faced difficulties with ability to lend to midcap companies. In Asia,
impaired exit valuations, which has dampened however, the attractiveness of private debt has been
100
Up to $250 million
40 $1 billion$5 billion
20
$5 billion or more
0
2010 2011 2012 2013 2014 2015 2016
Vintage year
6,000 22
Top 20 firms
20
5,000 18
16
4,000
Top 10 firms 14
12
3,000
10
Top 5 firms
8
2,000
Top 3 firms
6
1,000 4
Top firm
2
0 0
2009 2012 2016
GP put it, LPs want more and more of their money to 13.1 for the top ten funds over the same period.
in safe homesfirms that have grown over time by What we are seeing, then, is consolidation of
developing high-quality, consistent processes. LPs capital to a smaller number of larger funds, but
not necessarily fewer firms raising them. In other
This would seem to imply a consolidation of assets words, we are seeing growth in the number of firms
in the industry, with the largest GPs absorbing capable of raising multibillion-dollar funds
more and more of LPs capital. Yet when considering an exciting development for the industry.
firms, rather than funds, we see only minimal
consolidation (Exhibit 8). The portion of annual The biggest obstacle to further consolidation
fundraising that flows to the top firm has remains the industrys strong reliance on talent.
increased very slightly since 2014, from 2.2 to As one GPs managing partner reminded
2.6 percent. The portion of fundraising flow- us, With people and culture so important in this
ing to the top five and top ten firms has actually industry, consolidation doesnt work; you
decreased since 2014, from 8.3 percent to cant just gather up a bunch of smaller players and
8.2 percent for the top five, and from 13.4 percent combine them into one big one.
Underweight Overweight
Difference between current and target allocations for median limited partner,
percentage points
Type of limited
partner Private equity Real estate Infrastructure Private debt Natural resources
Endowment and
2.0 2.5 2.8 2.0 2.1
foundation
Private-sector
1.0 3.5 2.1 3.0 3.1
pension fund
5,000
2,500
1 Firms that have raised a fund in previous 10 years. If a rm has not raised a new fund in past 10 years, it is assumed to be defunct.
2 Compound annual growth rate.
Source: Preqin
Exhibit 11 The portion of the US market at investable valuations is at or near historical lows.
Russell 3000 stocks trading below median then-current buyout multiple, 200516, %
75
50
25 Below median
buyout multiple
Private equity report 2017
Exhibit
0
12 of 19
2005 2011 2016
786
716
581 609
530
454 436 437
361
308
230
165 185
124 152 94 99
61
2 7 3 7 13 19 31 42
1990 1994 1998 2002 2006 2010 2014 2016
Exhibit 13 Only North America showed a meaningful increase in private equity deal activity in 2016.
B2B3
B2C4
Energy5
Financial services6
Healthcare7
IT 8
Materials and
resources9
Total
1 Includes private equity buyout, growth and expansion, and venture capital. Only includes deals with disclosed deal volume.
2 Rest-of-world deal volumes refers to global deal volume less Asia, Europe, and North America.
3 Includes commercial products, commercial services, business transportation, and other business products and services.
4 Includes apparel and accessories; consumer durables and nondurables; media; restaurants, hotels, and leisure; retail; nonfinancial
grew 81 percent from 2015 to 2016, in large part was the lone bright spot for B2B: deal volume
fueled by megadeals. Increasing use of leverage, as increased 27 percent in 2016. Deal volume decreased
more software deals are done on the back of significantly in B2C globally, perhaps as a result
recurring revenue streams, may also have helped of persistently high and increasing deal multiples.
increase deal volume. In Europe, deal volume
fell sharply in 2016 for all sectors except healthcare, In closed-end infrastructure funds, deal volume rose
which posted a modest increase of 7 percent. Asia (from $361 billion in 2015 to $430 billion in 2016), as
1,700
Total 7.4 26.8
1,500
1,300
1,100
700
500
3.0
1.0
0
2006 2011 20162
33 33
28
31 25
22
Overall same-quartile persistency
Top-quartile persistency
13 12
Note: Persistency is measured with immediate successor fund (eg, Asia Buyout Partners IV would be successor to Asia Buyout Partners III).
Source: Preqin; McKinsey analysis
100
80 2nd quartile
Top quartile
60
3rd quartile
40
Bottom quartile
20
0
1995 1997 1999 2001 2003 2005 2007
1 We identied successor funds by name (eg, Fund Partners I, Fund Partners II, Fund Partners III).
How likely is your institution to do any of the following in the next 5 years?, %1
Unlikely or very unlikely Neither likely nor unlikely Likely or very likely
Infrastructure 5 21 74
Real estate 5 21 74
Natural resources 41 15 44
Real estate 13 13 74
Infrastructure 21 28 51
Real estate 23 18 59
LPs pursuit of such cost-optimizing strategies.9 We expect that these trends will only accelerate. In
And, as one private equity CEO reflected, a 2016 survey of 36 leading institutional investors
Co-investment is a first step for LPs to get their (all institutions that are truly transforming
feet in the door for eventual direct investments. their ways of working), McKinsey found that over
Direct investing is particularly prevalent in asset 60 percent are likely or very likely to enter into
classes such as infrastructure, where the more strategic relationships with GPs in the next
economics (lower returns, high execution risk, five years (Exhibit 18). A similar proportion
long duration) and fee structure (1 and 10 of top LPs is preparing to build direct-investing
on gross returns of 8 to 10 percent) lead LPs to capabilities. In infrastructure and real estate,
manage them in-house. for instance, more than 50 percent of leading LPs
book must evolve beyond the same old cost-cutting by Cambridge Associates, Capital IQ, CEM Benchmarking,
PitchBook, Preqin, and Triago.
levers. As one CEO summarized, Cost today 2 Duncan Kauffman, Tim Koller, Mekala Krishnan, and Susan
has become table stakes. The differentiator is Lund, Look out below: Why returns are headed lower,
now growth. Creating top-line growth is and what to do about it, McKinsey on Investing, November
2016, McKinsey.com.
becoming more important, especially in a slow or 3 Private equitys all-time commitment record, Triago Quarterly,
stagnant macro environment. Leading firms December 2016, triago.com.
take efficiency gains and reinvest them in growth 4 We assessed committed capital over a trailing
rigorously connects talent to value said, Winners in healthcare private equity, McKinsey on Investing,
December 2016, McKinsey.com.
think bigger but also start smaller and move 8 Robert S. Harris, Tim Jenkinson, Steven N. Kaplan, and
faster. They think about what needs to get added Rdiger Stueke, Has persistence persisted in private equity?
to the existing business, and they redeploy Evidence from buyout and venture capital funds, Darden
Business School working paper, number 2304808, Fama-Miller
human capital to make those changes happen as
working paper, February 2014, ssrn.com.
quickly as possible. 9 See Reiner Braun, Tim Jenkinson, and Christoph Schemmerl,
Acknowledgments
Editor
Mark Staples
The next act in healthcare private equity Fine-tuning family businesses for a new era
(December 2016) (October 2016)
Three more reasons why US education is ready How leading institutions are changing the rules
for investment (November 2016) on portfolio construction (August 2016)
Look out below: Why returns are headed lower, Inside the mind of a venture capitalist: An interview
and what to do about it (November 2016) with Steve Jurvetson (August 2016)
How private equity adapts: A discussion with From big to great: The worlds leading institutional
Don Gogel (November 2016) investors forge ahead (June 2016)
The private market investing revolution Private equity in Korea: A discussion with
(November 2016) Scott Hahn (May 2016)