HomeFEG's InsightsSecond Quarter 2018 Private Capital Quarterly Review

Second Quarter 2018 Private Capital Quarterly Review

Solid Returns to Start the Year 

Following a calendar year in which public market returns were positive across almost every asset class—an unusual event—the first quarter saw modest declines across the board. Arguably by virtue of their sticky valuation processes, private markets remained positive across asset classes in first quarter of 2018. The distressed and resources sectors were the lowest returning strategies. Distressed strategies suffered from a lack of distress and resources were impacted by uncertainty in the energy market and other commodity markets, largely caused by political and regulatory factors.

In the venture capital sector, a resurgence of IPOs continued. There were eight venture-backed companies that went public in the quarter with valuations in excess of $1.0 billion, led by Docusign.¹ Acquisitions also occurred at similar valuations. Workday purchased Adaptive Insights for $1.5 billion before it was set to go public.²

The term “late cycle” continues to apply to equity and credit markets. High prices remain prevalent, supported by low interest rates and strong earnings growth.

Global PC Aggregate Dry Powder by Year



The last 10 years of private market returns have been healthy, with median fund returns ranging from 6% to 12%, depending on the strategy. U.S. equities were up 9.6% over the same period, while non-U.S. equity markets, bonds, and REITS gained between 3% to 4%, indicating most private market investors have earned a premium for taking on liquidity risk.³ Notably, return dispersion remained high despite a general increase in transparency in private markets over the last decade, indicating the importance of manager selection.

Global PC Aggregate Dry Powder by Year


1, 2  Pitchbook – NVCA Venture Monitor, 2Q 2018
3 Russell 3000 Index, MSCI EAFE Index, MSCI Emerging Markets Index, Barclay’s Aggregate Bond Index, and NAREIT Index, as of March 31, 2018

Private Equity 

Venture Capital

Fundraising and Investing
  • Globally, venture funds raised approximately $25.6 billion in commitments in the first half of 2018, rebounding from the first quarter level.¹ While there is a certain unevenness to the data depending on when funds close, the capital flowing to venture capital funds remains elevated and is on pace to exceed the 2017 total.

Venture Fundraising and Estimated Number of Active Funds

Investment Activity
  • Reflective of the fundraising environment, median deal sizes rose in 2018 with late-stage financing rounds (Series C and Series D) at a 10-year peak. Notably, venture-backed companies have chosen to remain private longer in this period. As a result, these larger companies have pushed up the size of the average investment in late-stage deals.² Series A and Series B rounds are also trending higher as funds deploy more capital into these transactions.

  • Some fund managers and founders cite the falling costs of computing, storage, and customer acquisition—sales, marketing, etc.—as reasons to grow their business before taking outside capital from venture funds. This results in larger companies at each financing round stage. 

Median Deal Size by Financing Round

  • Pre-money valuations of venture-backed companies continued to increase across both early- and later-stage companies. The median pre-money valuations for venture-backed companies rose between 32% and 47% in 2018 compared to the level in 2017.

Median Pre-Money Valuation by Financing

  • Venture-backed companies received $137 billion of funding in the first half of 2018, an unprecedented amount. This far exceeds the amount of capital raised by venture funds. The emergence of mutual funds and hedge funds drove the increased amount of capital from 2014 to 2017. More recently, Softbank, family offices, and corporates have driven capital flows to companies.

    Venture Capital Investment Activity

  • The number of mega rounds—financing rounds of $100 million or more—rose dramatically in 2018. The 93 mega round deals in the first half of 2018 nearly matched the total of the prior year. It remains to be seen whether this is a long-term shift as companies stay private longer or the result of a long bull market in the technology sector.

Venture Capital Investment Activity

Exit Environment
    • Exit activity of venture-backed companies slowed in the first half of 2018 and declined relative to the same period in the prior year. The number of acquisitions (trade sales) also fell relative to 2017, although the number of initial public offerings (IPOs) was little changed.

    • The aggregate value of those exits in the first half of 2018 fell below the level for the prior year. There are also signs of a strong pipeline of IPO activity in the coming quarters.

Venture Capital Investment Activity

  • Venture fund performance by vintage year rose steadily from 2005 to 2011 but has since moderated. More recent vintages are not fully realized and the most recent vintages are not fully deployed. Funds that were able to achieve early exits or sizeable financing rounds likely experienced a boost to their performance.

VC Performance



The duration of the current capital flow and valuation trends is unclear. Certain structural changes to the market may be influencing the data. These changes include companies staying private longer; sources of capital from non-traditional venture fund sources, such as public cross-over investors or larger corporate investing; and the falling cost of scaling businesses. Performance has been strong, but remains meaningfully unrealized.


1, 2 Pitchbook, data as of June 30, 2018



Fundraising and Investments
  • Fundraising for global leveraged buyout funds slowed during the second quarter of 2018. Global leveraged buyout funds raised roughly $41 billion of aggregate capital commitments during the quarter and, as of quarter-end, 87 leveraged buyout funds had raised approximately $105 billion. This amount is down roughly 40% from the same time period in 2017.¹

  • Approximately $43 billion, or 41% of the capital, was raised by North American-focused buyout funds. Similarly, another $43 billion, or 41% of the capital, was raised for European-focused funds. The rest of world represented approximately 18% of aggregate capital commitments raised. This is not surprising, given that control equity transactions are more common in North America and Europe.²

  • Over the last 10 years, capital commitments have become more concentrated in the largest funds; since 2008, the average global buyout fund raised has grown from roughly $750 million to $1.2 billion.³

BO Fundraising and Estimated Number of Active Funds

Investment Activity

  • As of June 30, 2018, the average purchase price multiple for middle-market buyout transactions during the year was 10.6x earnings before interest, taxes, depreciation, and amortization (EBITDA). Leverage ratios remained relatively constant. According to S&P Capital IQ, the average debt multiple for middle market LBOs was roughly 5.5x EBITDA, below the 2007 peak of 5.9x EBITDA.⁴

  • Equity contributions in large buyout transactions remained steady at roughly 40%. The peak was 46% in 2009 when financing was scarce, and the low point was in 2007 when the ratio dipped below 30%. Equity contributions in middle market transactions were little changed during the quarter, at 44%.⁵ It is important to note, however, that the S&P Capital IQ data only represents a sample set of leverage buyout transactions executed during a given time period, which may not be representative of the area as a whole.

Average Purchase Price Multiples and Equity Contribution

Exit Activity
  • Approximately $163 billion of value was generated by 714 private equity-backed exits during the second quarter. Despite lower volume, exit sizes continue to rise—the median buyout exit value reached $231 million through the first half of the year, a 15.5% increase over the prior year. According to Pitchbook, one reason for the decline in volume is that private equity sponsors are struggling to find strategic acquirers for portfolio companies.⁶

  • Trade sales to strategic or financial acquirers represented the majority of global buyout-backed exits. Initial public offerings (IPO) accounted for roughly 7% of the aggregate number of exits.⁷

  • Since the global financial crisis, median holding periods of private equity investments have increased from roughly three years to five years. Longer holding periods are likely due to an increased emphasis on add-ons and operational improvements on the part of private equity firms to drive value creation.⁸

BO Exit Activity

  • Performance has been strong on a one, three, five, and 10-year basis, with time-weighted returns of 20.7%, 14.0%, 14.2%, and 9.4%, respectively.⁹

  • The dispersion of returns between top and lower-quartile funds has consistently been over 800 basis points, demonstrating the importance of manager selection.

BO Performance by Vintage Year

  • Year-over-year, fundraising for global leveraged buyout funds fell during the first half of 2018. Though notable, FEG believes this number is skewed due to the number of mega funds that were raised during 2017. Near-record levels of available capital (i.e., dry powder) combined with elevated purchase price multiples are reason for concern within the buyout strategy. Investors should remain cautious and continue to look for managers with clear competitive advantages and investment philosophies built on fundamental value.

1, 2, 3, 6, 7, 8 Pitchbook, data as of June 30, 2018

4, 5 S&P Leveraged Buyout Review – Second Quarter 2018

9 Thomson One – Horizon Summary Report as of March 31, 2018

Private Debt

  • According to a 2018 Preqin Global Private Debt Report, in the second quarter 2018, 22 private debt funds raised a total of $25 billion, up nearly $0.6 billion compared to the second quarter 2017 and up $5.3 billion versus the first quarter of 2018. Despite the fact that there are more private debt funds in the market than ever before (389), fundraising for private debt funds only reached $44 billion during the first half of 2018, trailing the same period in 2017 which saw $49 billion in fundraising. By number, direct lending managers led fundraising, closing 10 funds for $7.8 billion in commitments in the quarter. By assets, distressed debt managers closed on $14 billion, with GSO Capital Solutions Fund III attracting a robust $7 billion in capital commitments. Direct lending remains the primary fundraising story, with nearly half of all funds in the market and half of aggregate targeted capital raises earmarked for direct lending strategies.

  • The amount of capital being raised for direct lending strategies continues to be concerning, as too much money chasing too few opportunities may lead to weak performance. This concern is somewhat mitigated by the recognition that private lenders are replacing a portion of the capital previously provided by public financial institutions. Aggressive players at the margin will always push the limits, but FEG believes opportunity for growth in private lending remains, brought about by the secular change in risk activities undertaken by financial institutions.

Fundamental Backdrop
  • Fundamentals in middle market lending remain stable, as the table attests, despite increased purchase price multiples for the equity in these transactions. Debt/EBITDA remains elevated, yet deals are well supported by strong earnings and a meaningful equity cushion. The specter of higher interest rates could increase the cost of capital to companies, which could impact currently muted default rates, although many of today’s deals are light on the covenants that might trigger a default. Transaction volume in the U.S. middle market is down from last year’s pace and remains generally soft given the high pricing environment.

Lower Middle Market Fundamentals

Distressed Update
  • Distressed managers have been raising “war chests” over the past few years—e.g., $14 billion raised in the first half of 2018—in preparation for the next distressed cycle, although many have wisely remained reluctant to call capital amid the strength of the current bull market. Indeed, the distressed ratio—bonds trading at more than 10% over Treasuries—remains well below historical average, measured at 2.7% as of July 31, 2018. Corporate balance sheets, however, may be vulnerable to a downturn. Nearly half of investment-grade companies are rated BBB, which is a record, and up from roughly one-third in 2009.

Middle market volume by year



  • Demand for private debt strategies remains robust, as institutional investors continue to embrace the strategy amid lackluster return potential from public credit instruments.

  • Middle market fundamentals remain reasonably healthy, reflecting late cycle characteristics, while transaction volume remains well below the peak pre-recession years.

  • In the distressed sector, European opportunities remain prevalent and growth has improved markedly. In the U.S., defaults remained few and far between. A broad-based U.S. distressed opportunity remains in the offing, absent a U.S. recession.


Private Real Estate

  • Real estate values for “core” properties, as measured by the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index (NPI), experienced a total return of 1.8% during the second quarter, following a 1.7% gain in the first quarter. The index gained 9.6% on an annualized five-year basis as of June 30, 2018.

  • Driven by the growth of e-commerce, the industrial sector was the top performer, gaining 3.6% in the second quarter. Alternatively, retail recovered from its first quarter return of 0.7% to a return of 1.3% in the second quarter. Due to increases in new supply in the apartment sector, rents rose by only 2.3% in the second quarter compared to last year, the slowest annual increase since 2010.¹, ²

  • Property fundamentals strengthened in the second quarter as occupancy for NCREIF-tracked properties increased to a new 16-year high of 93.8%.³ Industrial had the highest occupancy rate, at 96.7%, followed by retail at 92.8%. The implied valuation cap rate increased slightly during the quarter to 4.9%, compared to 4.8% in the first quarter.⁴

  • The REIT sector’s discount to net asset value (NAV) decreased during the second quarter as M&A activity highlighted the ongoing price disparity between public real estate securities and their underlying NAV. According to NAREIT, M&A activity in REITs totaled $49 billion in the first five months of 2018, a figure slightly lower than the entire M&A volume for 2016. Notable transactions included Blackstone’s acquisition of Gramercy Property Trust and LaSalle Hotel Properties, as well as the acquisition of Education Realty by Greystar Partners.⁵

  • As the Federal Reserve has signaled an intention to raise rates two more times this year, the spread between cap rates and the 10-year Treasury continues to narrow. With strong institutional demand for real estate and the supply of foreign capital, the upward pressure that rising interest rates place on cap rate valuations may be muted.⁶

National Property Index Sector Returns

Capital Markets
      • New commercial mortgage-backed securities (CMBS) issuance totaled $21 billion in the second quarter, bringing the year-to-date total to $40.4 billion, an 18.5% increase over the same period in the prior year. Notably, there was an increase in activity in June, with 17 deals executed for a combined balance of $11.4 billion.⁷

      • From the beginning of the year through May, agency multifamily lending volume was robust, totaling $43 billion. Average agency fixed-mortgage rates with a seven to 10-year term averaged 4.6% in the second quarter, up from 4.4% during the previous quarter.⁸

      • According to CBRE, banks were active in the second quarter, capturing nearly half of the lending volume while keeping underwriting measures consistent from the first quarter. Capturing 21% of the lending volume during the quarter, life companies are expected to provide a meaningful source of originations for the remainder of the year.⁹

      • Amid a rising interest rate environment, borrowers saw some relief from a continued tightening of commercial loan spreads during the second quarter. The average spread on seven to 10-year fixed-rate, ~50% loan-to-cost loans was 178 basis points, which was down 30 basis points from the first quarter.¹⁰

      • As of the end of the second quarter, there were 624 closed-end private real estate funds in the market, an increase from approximately 570 at the beginning of the year. North American-focused funds continue to dominate the fundraising market, with five of the largest funds raised in the second quarter targeting the U.S.¹¹ As of mid-year 2018, North American-focused private real estate funds held $278 billion in dry powder, according to Preqin.

U.S. CMBS Issuance




1, 4 www.ncreif.com April 25, 2018
Wall Street Journal, “Looking for an Apartment? It Is a Great Time to Rent,” June 27, 2018
3, 8, 9, 10 
CBRE Q2 2018 U.S. Lending Figures

5, 6 PwC’s US Real Estate Deals Insights Q2 2018
Trepp CMBS Research: Q1-2018 Issuance Recap, July 2018
11 Preqin Quarterly Update: Real Estate, Q2 2018

Natural Resources

  • Oil prices rose 14% in the second quarter, closing at $74.15/barrel compared to $64.94/barrel at the end of the first quarter. Key factors driving higher prices included heightened geopolitical issues in the Middle East and an ongoing rebalancing of supply/demand in the oil markets. OPEC met in late May and agreed to increase production by up to 1,000,000 barrels per day, but prices rose through June amid uncertainty around the OPEC’s ability to implement production increases due to constraints in spare capacity.¹

  • A major theme during the quarter was the ongoing shortage of midstream energy infrastructure in the Permian Basin, which represents one of the few areas of significant production growth worldwide. This lack of takeaway capacity—midstream pipelines to move oil out—resulted in widening price differentials for Permian oil and contributed to concerns regarding supply shortages. Cuts in capital expend-itures by oil companies during the downturn over the past four years has also contributed to higher prices.²

  • Natural gas prices rose 7.0% during the second quarter, closing at $2.92/MMBtu, compared to $2.73/MMBtu at the end of the first quarter.³ Investors maintain a cautious outlook on natural gas due to the expected addition of infrastructure in the Appalachian Basin, along with expectations for additional supply as a result of associated gas produced in tandem with new oil production in the Permian Basin. Both of these factors could contribute to increased supplies.

  • On a longer-term basis, increased demand for natural gas should come from rising industrial demand, liquid natural gas (LNG) exports, and ongoing coal-to-gas switching by power producers.⁴

  • According to energy services firm Baker Hughes, the U.S. oil rig count ended the second quarter at 858, compared to 797 at the end of the first quarter, an increase of 7.6%.⁵ On a year-over-year basis, the total U.S. oil rig count increased by over 100 rigs, a 13.5% increase. Nevertheless, the rig count remains well below the peak of over 1,600 rigs nearly four years ago in the fall of 2014. The U.S. total natural gas rig count finished the second quarter at 187, a 3.7% decrease from the first quarter. Year-over-year, the U.S. total natural gas rig count increased 1.6%.⁶

  • The fundraising environment for private energy continues to be dominated by mega-funds, with the five largest energy funds currently in the market all targeting $5 billion or more in capital commitments. Among these groups are Energy Capital, Natural Gas Partners, and EIG.

  • Despite improvements in commodity prices, upstream deal volume fell to its lowest level in two years and total transaction value in the sector declined to a three-year low.⁷ The key factor driving lower deal activity was uncertainty around commodity prices, as oil futures remain in backwardation, in which futures prices are lower that current spot prices. There were only five deals over $1 billion completed during the quarter and spending on acreage remained subdued.⁸

  • Public energy companies have shifted to increased capital discipline and reduced leverage compared to the “drill at all costs” mentality that dominated the industry prior to the downturn, resulting in fewer deals.9

Crude Oil and Natural Gas Prices


1, 4, 7, 8 EnCap Investments, Energy Capital Fund, Quarterly Review (Section II: Industry Overview) 
2 International Energy Agency, July 2018
3 EIA (Energy Information Agency) Report, July 2018
5, 6 Baker Hughes, July 2018 www.bhge.com

This report was prepared by Fund Evaluation Group, LLC (FEG), a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Fund Evaluation Group, LLC, Form ADV Part 2A & 2B can be obtained by written request directly to: Fund Evaluation Group, LLC, 201 East Fifth Street, Suite 1600, Cincinnati, OH 45202, Attention: Compliance Department.

The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it. FEG, its affiliates, directors, officers, employees, employee benefit programs and client accounts may have a long position in any securities of issuers discussed in this report.

Index performance results do not represent any managed portfolio returns. An investor cannot invest directly in a presented index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. 

Neither the information nor any opinion expressed in this report constitutes an offer, or an invitation to make an offer, to buy or sell any securities.

Any return expectations provided are not intended as, and must not be regarded as, a representation, warranty or predication that the investment will achieve any particular rate of return over any particular time period or that investors will not incur losses.

Past performance is not indicative of future results.

Investments in private funds are speculative, involve a high degree of risk, and are designed for sophisticated investors.

An investor could lose all or a substantial amount of his or her investment. Private capital funds’ fees and expenses may offset private capital funds’ profits. Private capital funds are not required to provide periodic pricing or valuation information to investors except as defined in the fund documents. Private capital funds may involve complex tax structures and delays in distributing important tax information. Private capital funds are not subject to the same regulatory requirements as mutual funds. Private capital funds are not liquid and require investors to commit to funding capital calls over a period of several years; any default on a capital call may result in substantial penalties and/or legal action. Private capital fund managers have total authority over the private capital funds. The use of a single advisor applying similar strategies could mean lack of diversification and, consequently, higher risk.

The S&P 500 Index is capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NCREIF Property Index is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only.

HFRI ED: Distressed/Restructuring Index
Distressed/Restructuring strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings. Managers are typically actively involved with the management of these companies, frequently involved on creditors' committees in negotiating the exchange of securities for alternative obligations, either swaps of debt, equity or hybrid securities. Managers employ fundamental credit processes focused on valuation and asset coverage of securities of distressed firms; in most cases portfolio exposures are concentrated in instruments which are publicly traded, in some cases actively and in others under reduced liquidity but in general for which a reasonable public market exists. In contrast to Special Situations, Distressed Strategies employ primarily debt (greater than 60%) but also may maintain related equity exposure.

All data is as of June 30, 2018 unless otherwise noted. 

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