Private equity (PE) firms have got record levels of cash.
It’s not necessarily a good thing
When anyone has lots of cash, they want to spend it.
So there’s a risk that with all this money, PE firms will use it unwisely because they are under pressure from their clients: investors don’t like their cash sitting around for too long.
This is because many clients, like pension funds or insurance firms, have obligations to provide a return on investment to their customers.
So if PE firms don’t start making deals soon, we might see these institutional investors withdrawing their money and finding other ways to make their cash grow.
The lack of dealmaking has already caused some traditional PE investors to look for other opportunities. For instance, the markets have witnessed an increased flow of money into Exchange Traded Funds (ETFs).
But how did this cash build up happen?
Global low interest rates have driven investors to search for higher yields.
Meanwhile, traditional PE target assets are currently commanding a higher than usual valuation because they know there’s a lot of cash and investment partners out there. This is making deal making difficult.
And the PE firms have themselves encouraged this cash build up: many are not charging their clients on money they hold which isn’t invested.
If PE investment activity doesn’t pick up soon, we may not only see cash withdrawals but the industry itself may suffer longer term reputational damage as a poorer way of investing money.