Michael Sonnenfeldt, Tiger 21
Scott Mill | CNBC
Private equity is currently ‘king’ among the members of Tiger 21 – a network of ultra-high-net-worth entrepreneurs and investors – according to founder and chairman Michael Sonnenfeldt.
The private equity sector had a particularly tough 2022 after a decade-long bull run, but has rebounded so far this year.
Sonnenfeldt told CNBC on Friday that Tiger 21 members, which collectively manage about $150 billion in assets, have tripled their allocation to private equity over the past decade and see further opportunities amid an expected boom for companies exposed to AI and the climate.
Most of Tiger 21’s members are entrepreneurs who have sold their businesses and are now concerned with preserving their wealth.
“Cash positions are about 12%, they’ve trimmed public equities, but our real estate fell a year or two ago because of rising interest rates, and private equity is king now – that’s where companies are still scaling up,” Sonnenfeldt said. .
“Of course the availability of credit makes it a little more difficult, but private equity is what our members are really focused on because if you have foundational companies that are growing quickly, they can outperform the market.”
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Private equity as a percentage of members’ portfolios has grown from 10% to 30% over the past decade, Sonnenfeldt revealed, with venture capital making up a larger share than ever before.
“Many of our members have seen that AI is a huge opportunity, climate is a huge opportunity and obviously the energy markets have done well, so our members really think that long-term fundamental growth will take precedence,” he says. added.
According to a quarterly report from EY, private equity activity rose 15% in the second quarter of 2023 compared to the first, with total deal values reaching $114 billion, driven by a surge in Europe.
But not everyone is convinced that the optimism is justified. Dan Rasmussen, founder and chief investment officer at hedge fund Verdad Advisers, told CNBC on Friday that the sector is facing a “perfect storm” in the wake of sharp interest rate increases and falling technology valuations.
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“There are three major issues facing private equity. The first is that most of private equity is debt-financed – about 60% of net debt to company value in an average buyout – and almost all of that debt is variable interest,” he said.
As interest rates have risen dramatically, the average interest cost for private equity firms has skyrocketed. The median interest expense as a percentage of EBITDA (earnings before interest, taxes, depreciation and amortization) in the private equity and venture capital sector was 43% in 2022, while the median for companies in the S&P500 According to Verdad Adviseurs, the index was 7%.
“The second problem is that private equity has over 40% exposure to the technology sector. Technology valuations have fallen, and when you see the multiples falling, that creates an additional problem,” Rasmussen said.
Cumulatively, this means that the private equity sector has bought companies at higher valuations than in the public markets, with higher levels of debt.
While some large tech companies with significant exposure to AI have seen valuations rise this year, lifting averages for the broader sector, smaller companies with higher debt levels generally have not seen the same boon.
The US Federal Reserve has raised rates by more than 500 basis points over the past 18 months, from a target range of 0.25-0.5% in March 2022 to 5.25-5.5% in July.
Although the Federal Open Market Committee opted this month to pause the rate hike cycle, the central bank has suggested that rates will stay higher for longer, which is generally negative for highly indebted parts of the market focused on rapid growth .
“From a quantitative perspective, the fundamentals of sponsor-backed companies look scary,” Rasmussen said in a research note earlier this year.
“Yet private equity remains the asset class of choice for sophisticated investors, with many endowments and family offices approaching 40% allocations. The financial fundamentals look far less attractive than you might expect given the high enthusiasm.”