Monday, January 13, 2014

Institutional Investors Haven’t Learned a Thing: Apollo Raises a Big Fund

Institutional Investors Haven’t Learned a Thing: Apollo Raises a Big Fund

Apollo Global Management just raised $18 billion in new commitments for its eighth private equity fund.[1]   When Apollo first began soliciting interest about a year ago their goal was to attract $12 billion and, they set a cap of $15 billion.[2]  The cap is designed to ensure that investors’ interests aren’t diluted and the fund doesn’t become unwieldy.  Two things are clear.  Obviously, there was enormous institutional interest in Apollo’s fund.  More importantly, investors have largely forgotten the pain of 2008.
West Coast Review (1999)
Back in 2006 and 2007, money managers were able to raise huge PE funds, and investors gladly agreed to let them increase the fund size to accommodate every last investor.  Many of those investments didn’t fare so well.  In surveys and news articles, investors swore that they would be more disciplined.   For a few years after the credit bubble the fundraising environment was challenging, and PE managers struggled to reach their goals, let alone reach the fund cap.  Despite all the rhetoric, investors hadn’t become disciplined.  Rather, they’d become cautious.  The years following the credit crisis were an excellent time to invest in private equity.  Disciplined investors would have redoubled their commitment to the asset class. 

In April 2013 Apollo’s CEO, Leon Black, told investors that this was a time to be selling rather than buying private equity assets.  True to his word, Mr. Black and his colleagues spent much of the year selling businesses and returning capital to their investors.   In due course, Apollo will be getting that capital back as it draws down the new fund.  It’s no wonder Mr. Black wanted to sell given the stock market’s meteoric rise since 2008.  Since Mr. Black’s speech, the market has risen another 16%.  In other words, it’s still a better time to sell businesses than it is to buy.  Nonetheless, institutional investors are clamoring to give Apollo their money.

Some investors will argue that Apollo is well aligned with investors because they’ve committed about $900 million (5% of the fund).  Since Apollo is sinking its own money into the new fund, they’d argue, Apollo must think this is an opportune time to invest in private equity.  Apollo is going to earn more than $200 million per year for the next five years or so from the new fund.  They don’t have to pay fees or carried interest on their commitment.  In short, the new fund is a much better deal for Apollo’s insiders than the average investor.

A little over five years after the crisis, banks are once again letting private equity firms use a great deal of leverage, albeit not quite at 2007 levels.[3]  The banks are also relaxing covenants and financial ratios.  Apollo alone will probably be able to acquire about $40 to $50 billion worth of companies with its new fund.  Moreover, their fundraising success is likely to be repeated by other major PE players. 

You can’t really blame Apollo.  If investors want to part with their money, Apollo might as well take it.  Apollo probably built a business plan for the fund based on raising $12 billion.  You can be certain they were going to earn a tidy profit on management fees alone.  The additional $5.1 billion in capital they raised beyond their target for the fund ought to generate an additional $60-$65 million in management fees, which will be a windfall.

If investors had any sense, they would have insisted that Apollo adhere to its $15 billion cap for the new fund.  However, institutional investors have an uncanny knack of piling into investments at precisely the wrong time.  I had hoped that they had learned some lessons from the pain of 2008.  I was wrong.


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