CG Carlyle Group Inc

By Telis Demos 

Private-equity firms have put up some ugly numbers in earnings reports so far. Investors should look past them.

Apollo Global Management, Blackstone Group and Carlyle Group all reported huge net losses in the first quarter -- more than $5 billion collectively. Those losses were mainly driven by declines in marks of the on-paper value of their myriad investments. That performance over the long run is what eventually determines the value of these firms. If they can't ultimately realize gains on their investments they earn less, can't fundraise and don't generate fees.

In the meantime however, these big private-equity firms are continuing to generate substantial management fees that represent actual money in the pockets of the firms and, via potential future dividends, investors. While declines in asset values do affect the base on which management fees are generated, there are substantial offsets to that for now.

For one, the firms have ample "dry powder," or uninvested capital, more than $250 billion between the three firms. That means they can keep putting money to work to earn fees on. The firms' deals with limited partners also can offset the impact of mark-to-market declines on fees; Apollo's fee-generating assets under management declined just 2% from the prior quarter, versus a 5% decline in total assets.

As for their investment performance, the numbers in the first quarter certainly weren't pretty. But in the context of what the broader market has done, they aren't outsize so far. Blackstone and Apollo both reported 21.6% declines in their corporate private-equity portfolios in the first quarter. That was about the same as the S&P 500, which was down 20% in the first quarter. And their other classes of investments, such as corporate credit and real estate, were down far less than the S&P 500.

There are some relevant caveats, too. For example, energy was responsible for the bulk of Blackstone's corporate private-equity decline. But much of the firm's energy-portfolio investments sit in dedicated energy funds, which means that the broader limited-partner base isn't exposed to losses in the sector.

The biggest hit to distributable earnings will be from realizing investments. It will be harder to sell assets, like taking a private company public, in this market. But the decline in firms' share prices already reflects this. Over the past three months, Apollo shares are down 15%, Blackstone's are down 22% and Carlyle's are off by 34%.

What investors should be considering now is whether returns on new investments can make up for any permanent impairment of existing ones. Times of distress are when private equity has historically shined.

The median annual returns on funds raised in 2009 were 13.9%, versus 8.1% on 2006 funds, according to consulting and advisory firm EY. EY also noted that private-equity acquisitions fell by 80% from 2007 to 2009, meaning some funds didn't take full advantage of distressed prices. This time, by contrast, large private-equity firms are already making new investments. Apollo, for example, made $40 billion in gross purchases in the first quarter, mostly in March, and $10 billion more in April alone. It helps that the big firms are so stocked with dry powder.

One challenge may be that prices and liquidity have rebounded so aggressively, the window for distress bets quickly narrowed. Further waves of distress would again hit portfolio companies' valuations -- but it would also create more offsetting opportunities.

(END) Dow Jones Newswires

May 05, 2020 07:14 ET (11:14 GMT)

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