In early 2020, just before the start of the coronavirus pandemic, the collapse of a major private equity-backed oil and gas company Southland Royalty was “unremarkable”.
As America’s shale industry struggled, the firm was the 43rd bankruptcy of its kind in the space of a year.
Critics of the industry – which controls around £5tn of assets globally – say the fate of Southland and hundreds of others like it, was due to wildly wrong estimates of how much companies are truly worth, The Telegraph reports.
Experts have stressed that these imbalances could have potentially devastating consequences for millions of people’s retirement savings pots.
This is because it is expected that pension funds will funnel even greater pools of money into private equity funds at “artificial prices”.
In the UK the Financial Conduct Authority (FCA) has begun a review into valuations of the whole spectrum of private assets from private equity and venture capital, to commercial property and hedge funds.
Its investigation has been prompted by growing fears over the impact of a sharp reversal in interest rates.
A former investment banker, now an academic at the Johns Hopkins Carey Business School in Washington DC, describes the way in which private equity values its investments as “the Wild West”.
Jeff Hooke said: “Maybe it was okay 15 years ago – you could say it was a niche part of the financial markets, a very narrow part of institutional portfolios, and the regulators could say we have bigger fish to fry. But in some cases, the big state pension plans have 25 percent to 30 percent of their assets sitting in these alternative investment vehicles.”
It is understood the Bank of England has given its full backing to the FCA’s interrogation, having warned of the risks from stresses in the private equity market several times.
In its March Financial Stability Report, the Financial Policy Committee (FPC) expressed fears that “illiquidity and infrequent re-pricing of private credit assets created uncertainty…and might expose investors to sharp revaluations and losses”.
The International Organization of Securities Commissions (IOSCO) has similarly warned of “hidden risks” in private markets from the sharp spike in rates.
BT’s pension fund, which is among the largest corporate retirement plans in the UK, has sunk a growing proportion of its investments in more privately-held assets, as its exposure to equities has rapidly shrunk. It has £1.1bn of £38bn of assets in private equity and nearly £9bn in property, credit, and infrastructure.
As part of reforms unveiled in the Chancellor’s Autumn Statement, managers of the Local Government Pension Scheme (LGPS) have been asked to more than double its allocation to private equity, from less than 5 percet to 10 percent, to help boost economic growth.
Globally, the private equity industry controls assets worth more than $6tn, according to a McKinsey report published earlier this year.
But, leverage buyouts, where the balance sheets of the companies that are being bought are loaded with large debts to fund their own takeover, are most vulnerable to wild swings in value.
