28, February, 2024
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Unraveling the £5 Trillion Private Equity Conundrum – A Looming Threat to Retirement Portfolios

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The collapse of Southland Royalty in 2020 marked a typical casualty in the energy sector’s boom and bust, but it also unveiled a concerning trend in private equity. As interest rates rise after a decade of record lows, critics argue that inflated valuations of buyout-backed companies pose a significant risk to retirement savings. The private equity industry’s ability to mark its own investments, often labeled as “mark-to-myth,” has raised alarms, prompting regulatory scrutiny.

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Key Points:

  1. The fate of Southland and similar companies raises concerns about the gap between paper valuations and actual worth, potentially impacting millions of retirement savings. Critics argue that the trend has intensified amid a prolonged period of low interest rates.
  2. The Financial Conduct Authority (FCA) has initiated a comprehensive review of valuations across private assets, including private equity. Growing fears of a sharp reversal in interest rates have prompted regulatory concern about potential risks in the private equity market.
  3. The private equity industry controls over $6 trillion globally, with leveraged buyouts (LBOs) being particularly susceptible to value swings. The surge in private equity deals during the COVID chaos, totaling $1.3 trillion in 2021, has raised questions about the accuracy of reported valuations.
  4. Private equity’s ability to determine its own asset valuations, often without real-time market assessments, is criticized as subjective. The “mark to market” practice is challenged as “mark-to-myth,” with concerns that valuations are optimistically high and may not reflect true market conditions.
  5. Institutional investors, including Calpers and BT’s pension fund, have increased allocations to private equity, raising concerns about illiquid assets. Major investors like Vincent Mortier and Nick Moakes warn of potential losses and a “shakeout” in the private equity sector.
  6. The US Securities and Exchange Commission (SEC) aims to impose stringent rules on private equity, hedge funds, and the property sector to enhance investor protection. However, these efforts face opposition, with critics labeling them a “vast power grab.”
  7. Tactics like the use of “continuation funds,” where a fund effectively sells a company to itself, are under scrutiny for delaying the discovery of true asset values. Critics argue that these practices can obscure problems within private equity portfolios.
  8. The private equity conundrum, if not addressed, could lead to a correction with potential consequences such as cuts to retirement benefits, increased taxes, or employees having to contribute more to their pensions to cover shortfalls.

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As concerns about private equity valuations grow, the industry faces a pivotal moment that could reshape its practices and impact the broader financial landscape.

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