When KKR decided to raise its largest European buyout fund earlier this year, the industry held its collective breath. Fundraising had been down sharply. Global economic conditions were spotty at best. And rising interest rates continued to put a damper on the lending market. Was now really the right time to swing for the fences?

Then came news in April that KKR successfully raised $8 billion for the fund. Call it brilliance or audacity? Maybe a little bit of both?

“Many of the larger, well known fund managers are simply plunging ahead with ambitions to raise larger funds than two or three years ago, with some degree of success,” Kelly DePonte, managing director for placement agent Probitas Partners, told Mergers & Acquisitions recently.

Limited partners today are mostly sticking to what they know – brand name funds with whom they can deploy a large amount of capital. Many smaller firms are getting the short end of the stick.

“The industry has shifted back to 90/10 – 90 percent of the capital going to 10 percent of the firms raising,” says Fraser van Rensburg, founder and managing partner of placement agent Asante Capital Group.

As another example, Goldman Sachs Group raised a $5.2 billion fund in February. The fund exceeded its initial target. But this is more the exception than the rule.

Fundraising totals showed a decline across all metrics in 2022 versus prior years. According to data tracker Pitchbook, $461.2 billion was raised by 597 private equity funds in 2022, compared to $467.8 billion raised by 1,032 funds in 2020, and $560.2 billion by 1,129 funds in 2021.

While total capital from funds raised in 2022 is comparable to previous years, what’s noteworthy is the 40 percent drop in number of firms funded. First-time funds really took it on the chin as just $16.1 billion was raised in 2022 by 86 first-time funds, compared to $19.7 billion raised by 188 funds in 2020, and $28.4 billion raised by 204 funds in 2021.

“Well-established brand-name managers have benefitted from LPs focusing on re-ups and existing relationships, even though established managers are noting re-up rates ranging between 70-80 percent of the last fund commitment size, which had been north of 100 percent since about 2015,” says Sinha Haldea, global head of the private capital advisory group with Raymond James. “To this end, private wealth channels are expected to play a big role in capital raising for blue-chip/well-known GPs going forward.”

While the larger firms can rely on re-ups to a certain extent, the rates are down from previous levels. According to the S&P Global Market Intelligence 2023 Private Equity Outlook Survey, a significantly higher proportion of North American LPs (25 percent) are considering changing GPs in 2023. Haldea notes that re-up rates had been north of 100 percent since 2015.

In some instances, the macro environment is forcing investors’ hands. Declining public market valuations have caused limited partners to deal with the “denominator effect”; as the size of their overall portfolio value has decreased due to public share price declines, their allocation mandates limit them from plowing more capital into private equity and other alternative assets. And so, smaller – or lesser known — or newer – funds have faced the music.

“The rest of the market (outside of brand firms) is crawling along or flatlining at best,” van Rensburg says. “A number of firms are shelving or postponing their fundraisings. Much of investors’ 2023 allocations have been spoken for already, leaving forward-planning mostly focused on 2024, but with uncertainty as to how much of the denominator effect would have worn off by then.”

According to the S&P survey, 45 percent of private equity executives expect fundraising to deteriorate this year while only 34 percent expect it to stay the same. Additionally, 24 percent of general partners predict poorer fundraising results compared to just 7 percent a year earlier.

Is there a fund size threshold for success? Van Rensburg says it’s not the simple.

“It’s all relative,” he says. “If CD&R comes back to market for a $20 billion fund and they raise $16 billion that wouldn’t be successful. But if New Mountain Capital came out with an $8 billion fund and they ended up at 10, that would be very successful. So it’s all relative to where they are.

“But look, I mean, any of the very big guys raising over $20 billion in this market would be incredible results, regardless of what the target on the cover is,” he adds. “You can’t ignore the target on the cover because it’s still to some extent has a bearing on the market opportunity that they are raising capital for, and it has bearing on what their previous fund size was.”

To be sure it is not all champagne and roses for the larger funds. Van Rensburg says small, first-time, emerging managers are struggling more than the larger managers, but that it is all relative. The more established managers are having more success with “lift-off” as a result of at least a contingent of existing investors who supported them earlier on and are more likely to continue due to their longstanding relationship, which emerging managers don’t enjoy. But larger managers are still struggling to fill in the rest of their target raise after the re-ups, he says.

DePonte says larger limited partners are looking to make large commitments which can only be met by similarly sized general partners.

“Those GPs are so large, it’s harder for them to generate alpha in their portfolios,” says DePonte. “They’re less volatile. So you’re probably less likely to lose money. But it’s difficult for them to generate higher returns.”

On the flip side, smaller limited partners feel that the larger funds will subject themselves to market risk.

“So you have another group of limited partners that really focus on, for example, smaller market buyouts,” he says. “Some of them also focus on, say, venture capital funds, which tend to be smaller and have a lot of specialists in them. But it’s getting harder to do that. Simply because there’s so many of these different funds out there.”

Many of the larger players in the buyout market have moved to become alternative asset managers, so while they have a large buyout fund, they also have a series of real estate funds, infrastructure funds, and private debt funds, among others. As interest rates and inflation have increased – making buyout liquidity more difficult – these larger asset managers can look beyond just private equity.

How to Raise a Fund in This Market

So what’s a smaller fund to do? Experts say firms looking to differentiate themselves in the market need to focus on three internal factors:

  1. The historical track record of the firm
  2. The ability and the stability of the team that generated that track record
  3. The fund strategy

Brian Jacobsen, a managing director with West Monroe Capital says, “It’s still the old school approach of if you put up really good numbers and you have a differentiated strategy, that’s repeatable. And so it’s less what someone might be doing this time around and more concentrated on the result of what they’ve been doing over the history of the firm.”

Investcorp, a global alternative investment firm based out of Manama, Bahrain, closed its Investcorp North American Private Equity Fund I LP with over $1.2 billion in capital commitments in February. Laura Coquis, global head of their institutional capital raising, says patience was a key part to their success.

“Everyone is being slightly realistic about the conversion of new names and new money to your platform or to your strategy,” she says. “If you think about diversification of your investor base; diversification by channel is something in everyone’s thought process. Fundraising doesn’t happen overnight, so it’s important to align your strategy with your firm, that your firm is aware of what that means for resources, both for investment teams and internal teams so that you can successfully implement that strategy.”

Lori Campana, a partner with Monument Group, the placement agent for HighBrook InvestorsHighBrook Property Fund IV which closed oversubscribed with $632 million in the final quarter of 2022, agrees that the keys are the track records and strength of the team and strategy.

“When (HighBrook) got initial capital commitments, they started to invest and as time passed, those investments were repricing either at the same value or higher. So they had made some very good investments early on so that investors could see what they were investing in and could underwrite. Having a pre-seeded portfolio generally benefits any general partner, if valuations hold steady or improve through some early value add,” Campana says. “Also, if there’s co-investment available, many limited partners like to see co-investment because it helps to average down their fees. Most important, demonstrating liquidity and performance in prior funds is critical.”