Buyout Firms Combing U.S. for Sky-High Sums to Invest

Private-equity funds are in a mad dash for cash.

Across the country, nearly 2,000 private-equity firms are making pitches to state retirement systems, corporate pension funds and wealthy investors in the hope of raising nearly three-quarters of a trillion dollars for their next, new funds â€" more than what was raised over the last two years combined.

The push is part of the life cycle of the private-equity industry, which raises investment pools from large institutions and others that typically last about 10 years. Buyout firms combine the money with borrowed cash to acquire companies over the first five or six years and then sell those companies or take them public â€" at a profit, if all works out â€" before the 10 years are over.

Buyout firms that last raised money during the boom era from 2006 to 2008 need to raise their next funds to maintain certain fees. Funds charge an annual management fee of 1.5 percent to 2 percent of money raised and take 20 percent of profits from their investments.

Pension systems across the country are now wading through the deluge of funds seeking fresh cash. Just last year, officials at the Massachusetts Pension Reserves Investment Management Board, which oversees $53.9 billion in assets, reviewed 179 offering memorandums, met with 85 potential new fund managers and attended 48 annual fund meetings.

Nearly all of the titans have joined in the derby for dollars, including Apollo Global Management, the Carlyle Group and Bain Capital.

For some, raising new, even bigger funds will prove extremely easy. Others, however, will walk away empty-handed or with a much smaller amount than they wanted.

“The consistent top-quartile guys, especially those who also did well in the recession, they’ll raise their money in nine months to a year,” said Lawrence Schloss, a longtime private-equity investor who oversees $145 billion in pension investments for New York City’s teachers, police, firefighters and transit workers. “Others just won’t be able to do that. If they have a plus-or-minus zero rate of return over the last seven years, well, that’s kind of a stinky fund.”

For many private-equity firms, the success of their fund-raising season will depend in large part on how their boom-era funds performed.

Those are the huge buyout funds raised during the golden age of private equity that went on a frenzied acquisition spree between 2005 and 2007. Using vast amounts of borrowed money, they bought big and small companies, often at sky-high prices. That sequence turned out to be a recipe for disaster when the financial crisis erupted in 2008.

Buyout funds that started to invest in 2006, for instance, have been among the industry’s worst performing. The median internal rate of return after fees is 8.2 percent, according to the research firm Preqin, the lowest since it started tracking buyout performance in 1980 and about half the average for the previous five years.

“If your last fund was horrible, that’s going to be a really big issue for you,” said Antoine Dréan, the founder of Triago, which raises money for private-equity firms.

Still, public and private pension funds are increasingly betting on private equity. Plagued by low yields on government bonds worldwide, pension funds and other investors are struggling to meet the long-term returns they need to provide benefits to existing and future retirees.

So they are shifting to riskier assets like private equity, commodities and real estate in the hope that they will bolster overall returns.

But pension investment chiefs are pickier than they were a few years ago during the buyout boom. That is because of the gaping performance gap between good, bad and even mediocre firms. Top-performing funds typically earn 10 percentage points more than the median.

As a result, private-equity funds that have shown steady, strong returns over the years and maneuvered well through the recession are raising new funds at breakneck speeds.

Silver Lake Partners, a technology-focused private-equity firm whose 2007 fund has earned an annual return of 15.5 percent through the end of March, raised a $10.3 billion fund â€" nearly $3 billion more than its initial target â€" in less than a year. Likewise, CVC Capital Partners, whose 2008 fund is returning 8.9 percent while an earlier 2005 fund posts annual gains of 17.4 percent, had investors practically throwing cash at it. CVC not only overshot its $12.2 billion target by $2 billion, but it raised its new fund in less than eight months.

But the comeback award has to go to Leon Black’s Apollo Global Management, whose $10 billion fund in 2006 was, at one point, being written off as its stakes in residential real estate brokerage company Realogy and the gambling company Harrah’s Entertainment (now Caesars Entertainment) were whipsawed by the economic recession. That fund has rebounded with an average annual return of about 10 percent. A 2008 fund is posting annual gains of 28 percent.

Investors, including the Oregon Investment Council, are racing to sign on to Apollo’s latest fund, which has raised $8.4 billion since just the beginning of the year.

“If you invest with the right groups â€" and we try to forge strategic relationships with firms â€" if they do what you hope they will do, when they come back to the market, you’ll re-up with them,” said Jay Fewel, the senior investment officer for the $66 billion Oregon pension fund, which has $15 billion invested in private-equity funds. The pension started investing in private equity in 1980.

But others firms are struggling in the competitive fund-raising environment. They are either taking longer to raise new funds, reducing the amount of money they are seeking and, in a handful of cases, shutting their doors when they discovered investors had closed their checkbooks.

With its 2007 European-focused fund posting returns of about 3.2 percent through the end of March, Apax Partners struggled to raise its latest fund, taking two years to raise $7.5 billion. Things were even tougher for Vestar Capital Partners, whose fifth fund, which started investing in 2005, is posting a 1.26 percent annual return. Vestar hoped to raise $2 billion for its sixth fund but ended fund-raising this spring with only $804 million.

In a statement, Vestar said while it was “highly likely” the firm could have raised more money, it chose to move forward, adding that the $804 million pool “represents ample firepower by any measure.”

The firm many say has a big question mark hovering over it is TPG, the investment group co-founded by David Bonderman.

TPG is not in the market raising a new fund, but some investors say, privately, that when it does, it may face a less friendly audience than it has in the past. Its fifth fund, a $15 billion behemoth that started investing in 2006, is flat. Its sixth fund, a $19 billion pool, had an annual return of 8.6 percent, after fees, at the end of June.

The New York City pension fund is not an investor with TPG, but Mr. Schloss, who was the former global head of CSFB private equity, said he was looking to trim and focus the numbers of private-equity funds that the pension fund invests with.

But he has run out of time. Hired by the city comptroller John Liu in 2010, Mr. Schloss was expected to leave at the end of the year when Mr. Liu leaves office. But last week, Mr. Schloss announced would step down from the pension system this week to join the investment management firm Angelo Gordon as its president in early November. “People like us â€" the big public pension funds â€" probably have too many managers anyway. You don’t need 100 managers,” he says. “You don’t want to re-up with the poor-performing managers and you want to give more money to the good guys.”

From his seventh-floor office across from City Hall, Mr. Schloss and his five-person private-equity team sift through fund documents, pore over performance reports, and meet with management teams and their outside consultants to separate the great from the mediocre.

The consistent, strong performers are an easy decision, he says. Second-quartile funds “have a shot if we were an existing investor,” Mr. Schloss said.

Can the underperformers even get a foot in the door? No, Mr. Schloss said. “We are thinly staffed and have little time to meet with bottom-quartile managers.”