Permanent capital vehicles are a mature investment strategy for large financial sponsors, Blackstone‘s (NYSE: BX) recent earnings make clear. Will middle market private equity firms look for sources of its own? If so, insurance companies could be the logical first step on the way to a buy and build strategy.
Buried in the buzz over top private equity companies’ earnings over the past week is the increasing shift toward permanent capital. The industry already embraces the concept of raising funds for deployment in acquisitions of “indefinite” duration: funds save on costs to raise, close, and dispose of assets in their portfolios, while earning higher (eventual) fees on commitments they hold for longer time horizons.
The idea is not new, but the rate of adoption is. And Credit Suisse analysts say it’s accelerating. We are approaching a tipping point where the composition of the largest private equity players’ fee-related earnings (FRE) derived from perpetual capital vehicles is so substantial it can offset the periodic FRE declines between flagship fundraises. The analysts note that Blackstone’s increasing share of permanent capital-derived fee revenue has several upsides: “high management fees (which also compound with appreciation), superior incremental operating margins, no net redemption risk and robust client demand given [Blackstone]’s strong brand/track record.”
Middle market private equity could take note. Many such funds are raised from direct limited partner commitments, but acquisitions offer an alternative path. What if seasoned alternative managers could tap large amounts of capital currently generating low returns?
Enter the insurance industry. Life insurers facing a slow rebound off low interest rates could remain interested sellers, according to a Deloitte analysis. The note also says that buyside interest from financial sponsors is expected to be strong throughout the year as PE looks to deploy capital.
Annuity and other life insurance product providers are a go-top source for permanent capital among large, publicly traded financial sponsors. Blackstone ran $100 billion of assets for insurance customers as of the end of 1Q. While growth in fundraising for permanent capital has come from high and ultra high net worth individuals, the company’s insurance business is another potential pool. Apollo Global Management’s (NYSE: APO) Athene and KKR’s (NYSE: KKR) Global Atlantic already provide captive pools of permanent capital.
And the kind of bite-sized assets more readily available to middle market PE might be on the block more often. Corporate carve-outs are expected to continue apace in the insurance sectors as companies right-size their portfolios, the Deloitte note says.
The permanent capital model tried and tested by the industry’s heavyweights could see a wave of adoption by smaller funds attracted to the lucrative fees. As insurance portfolios continue to hit the market this year, look for middle market PE to play a longer term investment horizon to access the trend.