Will Individual Investors Replace Institutional Investors’ Pending Retreat from Private Equity?

Dry powder, the amount of money private equity has at its disposal to make future investments, has gone up and up over the last ten years. The most obvious reason was the desire for institutions, which most famously include insurance companies, pension funds, and university endowments, to find yield on their troves of cash during a time when their traditional vehicle, bonds, were providing essentially zero yields.

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But now interest rates are climbing. We've seen two raises by the Federal Reserve Bank, which alone have accounted for a quadrupling of its rate already this year. And tomorrow, the Fed will reverse its quantitative easing, an act that will further heighten rates as it gathers steam. This will then lead to additional, much-anticipated rate hikes throughout the year.
Traditionally, rising interest rates result in institutions easing up on their commitments to alternative investments like private equity. They do not pull any "committed capital," but as that capital gets invested, they do slow down their rate of new commitments.

But unlike past pullbacks, the regulatory environment has eased, allowing individuals to participate in private equity funds to a much broader extent. Last week, the Wall Street Journal reported that the recent sharp decline in public equity prices has led individuals into a short-term run into private equity as they seek to avoid the daily ups and (especially) downs of the public markets. ("Investors Pile Into Private Equity Funds, May 26, 2022, page B9).

The longer-term trend behind this article places us in a fresh landscape, historically speaking. While there is no comprehensive registry of individuals' participation in the space, it is commonly thought that individual investors presently make up about 8% of funds under management by private equity. While this is a small number, the individual investors would logically be expected to be placing smaller bets than multi-billion-dollar institutions. As a result, they would also be expected to make up a higher percentage of the investment capital in small funds as opposed to large funds and thus be a more important player in the middle and lower-middle markets. Benchmark International's experience in these markets indicates this to be the case. The smaller the deal, the more we have seen the fund populated with individual investors.

But even our best estimate caps individual participation at around 20% in these markets. It thus remains to be seen if the recent frothiness in multiples that have arisen from so much capital chasing so few deals will remain the standard as institutions take their ball and go home and the smaller players take the court in their place.

  Author
  Clinton Johnston
  Managing Director
  Benchmark International

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