- Founder and Chairman Michael Sonnenfeldt told CNBC that Tiger 21 members, who collectively manage about $150 billion in assets, have tripled their allocation to private equity over the last decade.
- “Private equity is king now – companies are still growing there,” Sonnenfeldt said.
- But not everyone is convinced that the optimism is justified. Dan Rasmussen of Verdad Advisers said the industry was facing a “perfect storm” following sharp rises in interest rates and falling valuations.
Michael Sonnenfeldt, Tiger 21
Scott Mlyn | CNBC
According to its founder and chairman Michael Sonnenfeldt, private equity is currently “king” among members of Tiger 21 – a network of ultra-high-net-worth entrepreneurs and investors.
The private equity industry had a particularly difficult 2022 after a decade-long boom, but has recovered so far this year.
Sonnenfeldt told CNBC on Friday that the Tiger 21 members, who collectively manage about $150 billion in assets, have tripled their allocation to private equity over the last decade and amid an expected boom for companies related to AI and climate come into contact, see further opportunities.
Most Tiger 21 members are entrepreneurs who have sold their companies and are now dedicated to wealth preservation.
“Cash levels are around 12%, public stocks have been reduced, but our real estate went down a year or two ago due to rising interest rates, and private equity is king now – that’s where companies are still growing,” Sonnenfeldt said.
“Obviously the availability of credit makes it a little more difficult, but our members are really focused on private equity because when you have fundamental companies that are growing quickly, that can outperform the market.”
According to Sonnenfeldt, the share of private equity in members’ portfolios has increased from 10% to 30% over the last decade, with venture capital making up a larger share than ever before.
“Many of our members have recognized that AI is a big opportunity, that climate is a big opportunity and that energy markets have obviously performed well. Therefore, our members truly believe that fundamental growth will be favored in the long run,” he added.
According to a quarterly report from EY, private equity activity increased 15% in the second quarter of 2023 compared to the first quarter, with the total value of deals reaching $114 billion due to a strong increase in Europe.
But not everyone is convinced that the optimism is justified. Dan Rasmussen, founder and chief investment officer of hedge fund Verdad Advisers, told CNBC on Friday that the industry is facing a “perfect storm” due to soaring interest rates and falling technology valuations.
“Private equity faces three major problems. The first is that the majority of private equity is leveraged – about 60% of net debt to enterprise value in an average buyout – and that almost all of that debt is floating rate,” he said.
As interest rates have risen dramatically, the average cost of interest for private equity firms has skyrocketed. The average interest expense as a percentage of EBITDA (earnings before interest, taxes, depreciation and amortization) in the private equity and venture capital industry was 43% in 2022, while the average figure for all companies in the S&P 500 index was 7%, according to Verdad Advisors.
“The second problem is that private equity has over 40% exposure to the technology sector, technology valuations have fallen and when you see valuation metrics fall, it creates an additional problem,” Rasmussen said.
Overall, this means that the private equity industry has been buying companies at higher valuations than public markets and with higher leverage.
Although valuations of some large tech companies with significant use of AI have skyrocketed this year, pushing up averages for the entire sector, smaller companies with higher leverage have generally not experienced the same boon.
The Federal Reserve has raised interest 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 decided this month to pause the rate-hiking cycle, the central bank has suggested interest rates will stay higher for longer, which is typically a negative for heavily leveraged parts of the market aiming for rapid growth.
“From a quantitative perspective, the fundamentals of sponsor-backed companies look scary,” Rasmussen said in a research note earlier this year.
“However, private equity remains the preferred asset class for sophisticated investors, with many foundations and family offices achieving an allocation of almost 40%. The financial fundamentals look far less attractive than one would expect given the level of enthusiasm.”