Liquidity crunch is stalling fundraising; hot sectors cool

Fundraising prospects for 2023 across private asset classes haven't been so grim in a decade, with even the blue-chip alternative investment firms extending timelines for flagship funds to raise money well into the new year.

It's been a challenging fundraising environment for fund managers across all sectors. While managers are hopeful that the pace of commitments will pick up in 2023, gone are the days that alternative investment managers could close a fund in a couple of months.

Some of the most highly regarded, brand-name firms, even after a year, are having trouble hitting their targets, let alone their hard caps, industry insiders said.

There are lots of reasons for this, including liquidity issues among limited partners from the "denominator effect," which is the drop in public market assets boosting private market assets in investors' portfolios, and managers' penchant for raising larger funds faster, industry insiders said.

Limited partners were already running into some level of illiquidity in 2021 when commitments accelerated because managers were coming back to market more and more often, said Adam Bragar, New York-based head of the U.S. private equity practice of Willis Towers Watson PLC.

In 2022, capital commitments were down 1.4% to $497.3 billion as of Dec. 22 compared to $504.3 billion in all of 2021, Pensions & Investments data show. The number of commitments were flat at 129 as of Dec. 22, one less than in 2021, according to P&I.

"The four- or five-year intervals between funds was already out the window" before the current market volatility, Mr. Bragar said. Rather, venture capital firms waited only a year to raise money again, while buyout managers generally waited three years, he said.

Whether the slowdown in commitments will continue into 2023 depends on investors' current and projected liquidity, Mr. Bragar said.

"I don't think the current macro environment will help because it is putting pressure on that denominator effect," he said.

"So even though this is probably an attractive time to be investing, I would expect commitment paces to continue to be slower in 2023 than they have been historically," Mr. Bragar said.

Even the hottest private markets sector, credit, showed weakened fundraising in 2022, with total capital committed down 31% to $75.8 billion and the number of funds down 17% to 25, P&I data show.

Private equity was the only alternative investment category in which the number of funds and amount of capital committed increased in 2022. Asset owners committed a combined $296 billion, up 17.3%, in 73 funds, a 30% increase over the prior year, according to P&I.

However, fundraising by private equity funds worldwide was down 41.8% to $405 billion at the end of the third quarter last year, compared to all of 2021, and the full year 2022 is expected to be down 21.5%, according to Preqin.

Private debt funds fell 11% to $172 billion in the third quarter from all of 2021, Preqin data also show.

General partners should expect to take longer to close funds in 2023 than in the five years prior to the 2022 slowdown, Mr. Bragar said.

"Directionally, there are a lot of established managers who have had funds in the market for a year and have raised 75% of their targets or less," Mr. Bragar said.

In response, some of the largest managers are delaying the close of funds now raising money well into 2023.

Apollo Global Management Inc. extended the fundraising period for its latest flagship private equity fund, Apollo Investment Fund X, which has a $25 billion fundraising target, until the first half of 2023, said Scott Kleinman, co-president, during the firm's Nov. 2 third quarter earnings call. He said that Apollo had received $14.5 billion in commitments for the fund. It's 2017 predecessor closed in a few months at $24.7 billion, exceeding its $23.5 billion hard cap.

"Importantly, all capital closed in the remainder of '22 or the first part of '23 will accrue fees back to the fund's fee commencement date, which we activated on Oct. 1," Mr. Kleinman said.

TPG Inc. is also extending its fundraising into 2023.

"LPs remain in certain regions of the world overallocated" to alternative investments, said Jack Weingart, chief financial officer, during TPG's Nov. 9 earnings call.

"A lot of GPs are extending fundraising campaigns into next year. We've been planning to do that the whole time," Mr. Weingart said, adding that TPG executives have been discussing it since 2022's first quarter.

And fundraising will "remain challenging throughout most of the year (2023)," he said.

"There was an element of GPs kind of pre-launching fundraising campaigns coming into this year who didn't necessarily need the capital yet, and that kind of opportunistic fundraising launch will not happen next year," Mr. Weingart said.

He noted that aggregate fundraising for the industry was down about 20%. But he said TPG is on track, having raised $26 billion in the first nine months of 2022.

Carlyle Group Inc. also extended fundraising for private equity fund Carlyle Partners VIII.

Carlyle started marketing that fund on Sept. 10, 2021, and had raised $14 billion as of Sept. 30, Carlyle reported. Carlyle had set a $22 billion fundraising target for the fund, according to PitchBook Data Inc.

Peter J. Clare, chief investment officer of Carlyle's corporate private equity business and chairman of the Americas, said during a third-quarter earnings call that the firm would continue raising money for the fund into 2023 at the request of their investors.

"A number of our investors have come to us and said please, come back and see us in 2023 when I have more allocation," Mr. Clare said.

Even so, he acknowledged fundraising challenges and that Carlyle could be backing away from raising ever-larger private equity funds.

"The market is clearly congested" and fundraising for large buyout funds has slowed down, he said.

"We do expect that ultimately … all of our funds that we're currently raising now will in aggregate commitment be a similar size to the current vintages."

KKR & Co. Inc. executives see fundraising slowing in 2023.

"I think with market volatility, the tone of the fundraising market has become more challenging," said Craig Larson, partner and head of investor relations, on KKR's Nov. 1 earnings call.

In 2022 through Sept. 30, KKR raised a combined $65 billion, "already the second-most active fundraising year in our history, without a lot of flagships in the market," Mr. Larson said.

But that total lags the same period in 2021 when KKR raised a total of $102 billion during the first nine months.

"There's no doubt some U.S. pension plans are getting their bearings right now in trying to figure out where the market is going to go," said Scott Nuttall, co-CEO, on the same call. He said that firm executives are still talking to investors who are most interested in asset classes that can provide inflation protection or yield, such as credit, infrastructure and real estate.

"We're having a lot of good dialogues on those fronts, even with some of those that are still getting their bearings and may be more active early part of next year than the end of this year," Mr. Nuttall said.

Private equity valuations in some sectors are expected to drop. Technology and life sciences will probably see some pressure on their valuations because of the extended time it takes for those companies to produce "substantial gains" on investments in those industries, said Nick Tsafos, a New York-based audit partner in the financial services group of EisnerAmper LLP.

Meanwhile, valuations of companies with an ESG bent and in infrastructure are set to increase, Mr. Tsafos said. Infrastructure companies are set to get a boost from the federal infrastructure legislation increasing government spending in the sector, he said.

But even within those sectors, there are key differences, he said.

Companies' valuations could also rise or fall based on the strength of their balance sheets, the amount of debt they're carrying and the revenues or likelihood of revenues they are producing, Mr. Tsafos said. If a company has high amount of leverage, the question is what the debt was used for, he said. If debt is used to expand the company through a merger or acquisition, "that's good debt" as opposed to if it were used to cash out the founders, he said.

Jonathan Gray, president and chief operating officer of Blackstone Inc., acknowledged that fundraising will be difficult, and said the future prospects of portfolios depend on the asset type. He also admitted how tough it is now for alternative investment firms to raise new capital.

"I would acknowledge, it's harder out there," Mr. Gray said during the $950.9 billion alternative investment manager's Oct. 20 third-quarter earnings call.

"Investors are more capital-constrained. I think it will be tougher for many groups to raise capital, and that will be until markets get better," Mr. Gray said.

He also said investors have paused making commitments to real estate funds, due to rising interest rates and lower expected returns on some properties.

"As it relates to institutions … they become more cautious in this environment, so they don't allocate quite as much. They pause, we've seen this before," Mr. Gray said.

Blackstone was about halfway to its goal of raising a total of $150 billion from major institutions over its current 18-month fundraising cycle. That cycle's scheduled to end around mid-year 2023, he said.

"The challenge, of course, is in a rising rate environment, if you own a hard asset (that) feels like a bond, or worse an older office building, then I think you're going to see a challenge to value because the income is not growing much and rates have gone up," Mr. Gray said.

However, Blackstone executives still see rising rents and "value appreciation, albeit at a lower rate," in rental housing and logistics, he said.

Even so, real estate fundraising is expected to be rough across the globe, with asset owners everywhere challenged by the denominator effect, said Indraneel Karlekar, Pasadena, Calif.-based global head of research and strategy at Principal Real Estate Investors.

"That has slowed down their appetite for real estate, particularly private real estate," Mr. Karlekar said.

Overall, "2023 will be a year of calibration," he said.

"Inflation will determine everything we as investors will deal with in 2023," Mr. Karlekar said. Until the Federal Reserve stops tightening interest rates, real estate investors "will remain under pressure," he said.

"There will be a retracing of real estate values over the next six to nine months," Mr. Karlekar added.

One attractive real estate investment in 2023: commercial mortgage-backed securities, which tend to be overlooked by investors, Mr. Karlekar said. CMBS bonds are trading at a discount to their underlying net asset values, he said.

"They are basically priced for a recession. They're attractive because of the dislocation of the yields," Mr. Karlekar said.

In 2023, real estate investment trusts that were battered in 2022 could stage a comeback, making them a more attractive choice for investors, said Mathew Kirschner, portfolio manager, U.S. real estate at Cohen & Steers Inc.

"It comes down to what is being priced into different markets," Mr. Kirschner said. "The REIT market … has priced in two things: the increase in interest rates" and the prospect of slower growth.

Going forward, REITs should again offer above-average dividend yield and long-term returns, he said. REITs also helps diversify investors' portfolios with easy access to next generation asset classes such as cell towers, data centers and single family homes for rent, he said.

"Investors have access to a lot of different asset classes they can't access elsewhere," he said. Cohen & Steers had $29 billion of institutional assets under management in REITS and $3.9 billion in infrastructure as of Sept. 30.

Greg Olafson, co-president of the alternatives business at Goldman Sachs Asset Management, said that "without question" it will be more difficult to raise new capital. But, he agrees that the funds that will be raised will tilt toward infrastructure, credit and to a less extent, real estate, he said.

"Real estate will take longer to work through because it is a rate-sensitive product," Mr. Olafson said.

While infrastructure, credit, energy transition and digital transformation assets will be affected by the economy, they are supported by "strong secular trends in an inflationary environment," Mr. Olafson said.

Despite secular trends that support these assets in the long term, some of the hottest infrastructure sectors such as communication infrastructure, cell towers and data centers may continue to underperform in 2023, said Tyler Rosenlicht, Cohen & Steers' senior vice president, a portfolio manager for global listed infrastructure and head of natural resource equities.

These are high growth businesses and rising interest rates have a greater impact than on slower growth companies, Mr. Rosenlicht said.

And while cell towers and data centers are long-term infrastructure assets, "they are very tethered to the tech world," he said.

"I think a lot of the tech industry was focused on revenue growth and not profitability and free cash flow growth," Mr. Rosenlicht said.

Now that the tech industry's focus has shifted to profitability, tech companies are likely to be more guarded on spending, causing a cut back on the number of data centers they add, he said.

These factors could cause cell towers and data centers to post lower growth than expected 18 months ago, Mr. Rosenlicht said.

Across alternatives, the slower fundraising in 2023 will divide managers between the haves and have nots, said James Clarke, a managing director at Blue Owl Capital Inc.

Asset owners will have less capital to commit and so will concentrate their investments to a fewer number of alternative investment managers, Mr. Clarke said.

While private credit outperformed public debt in 2022, if interest rates continue to climb in 2023, an argument could be made to decrease private credit allocations in favor of publicly traded fixed income, he said.

Even so, the credit asset class was battle tested during the market volatility blip at the start of the pandemic, and private equity firms are sitting on $1.5 trillion of dry powder and will need loans that are now mostly available from private debt lenders, Mr. Clarke said.

However, private market managers may not invest that dry powder just yet. The anticipated result of the rocky fundraising trail in 2023: Many managers may be in no hurry to invest the capital they already have and take full advantage of funds' typical five-year investment period.

The capital that is on the sidelines in the form of dry powder "could remain on the sidelines," said Willis Towers Watson's Mr. Bragar.

"There's been horror story after horror story of GPs not able to raise funds," he said. "Let's say you're a GP and hear your GP friends are in the market for nine months, a year or more than that and unable to hit their targets. Will you be willing to deploy funds that quickly thinking you may run into the same issues?"

Managers that invest at a slower pace could still charge management fees on un-invested capital and wait for fundraising to pick up, Mr. Bragar said.