Buyout Bubble Popping

Agreed. PE is going to get consolidated similar to HFs, but slower given MTM performance and illiquidity.

The golden age is over

What do you consolidated? HFs are much more fragmented. You don't have many $3-4bn HFs out there but ten times as many $30-40mm hedge funds.

Yes, I can’t imagine this view isn’t consensus at this point. It’s very obvious this is inevitable, not sure how anyone can argue otherwise. 
 

the larger will get larger. Returns will get compressed. Fees get compressed. Economic opportunity gets compressed. Barbell approach between large and small end of spectrum. Has happened to every single asset class. PE is no different, just a matter of time 

Most of sponsor processes im in involved the assets are doing terrible with a ton of headwinds.  

The truth of the matter is that nobody knows for sure what the future of buyout is. However, there are strong reasons to believe OP is correct:

1) Interest rates. Unlikely to go back down to 0 which was a gigantic (and I mean gigantic) tailwind for PE the last 30 years. If you decompose returns it was pretty much all driven by multiple expansion during this period which is unlikely to be the case going forward. We’re in a fundamentally different world.

2) Capital overallocation: Apollo went from $40B to $650B aum since 2008. Marc Rowan two weeks ago literally said it himself “we were lucky to be in a time when rates were coming down and investors were hunting for yield.” That penetration growth tailwind has capped out. PE, and in particular corporate PE, isn’t a growth area anymore. When Blackrock bought GIP this year, Larry Fink literally said “PE isn’t a growing area, we see infrastructure as the future.”  Now, these guys can be wrong and have been in the past but their opinions do hold weight, especially when it goes against their own self interest.

3) Processes now are insanely competitive for the best assets. ESG type stuff going for 20x+ and LPs are getting more and more concessions in order to commit to a fund. Recently we had a $500M cheque which was syndicated to $250M due to LP fee-free coinvest. The blended fees are coming down and LPs are pushing hard.

4) tax regime and scrutiny - just look at all the scrutiny on PE in the real world. Over a 20 year career you can bet that carried interest tax is going up not down 

Yes.  So many funds overpaid for assets over the last few years.  Can't sell assets for what they want.

As discussed, sure, higher interest rates have had a material impact, but the reality is, this was the catalyst for making the music stop - everyone knows the old game of multiple expansion is largely over for your everyday i.e., not highly sought after assets.   

This doesn't mean its over for PE, but the glory days for a majority of funds most likely is.

Sitting on the LP side of things:

There was way too much dry powder raised in the lead-up to this point, a lot of it concentrated in smaller and newer funds with limited track records. What is raised must be deployed, and so you end up with sub-par assets at questionable valuations. 

Across the industry you can already see the early stages of the flight to quality play out. Most of our portfolio this past year has been slow to monetize (excluding things like dividend recaps which are mostly a "pray things are better later" sort of deal), but there are a couple of notable exits that have materialized and pretty strongly too. Look at the Leonard Green asset being acquired by Home Depot for example.

If you think it's a tough fundraising environment right now, check back in a couple of years when a lot of these funds are going to have to defend their portfolios made at the peak that still haven't developed.

My own thesis as an LP, which I think is a common view, is that if you've been counting on private markets beta to do the heavy return lifting, you're going to be disappointed, but if you have a more concentrated portfolio of top tier managers your returns should still stack up.

So, assume I'm at what would be considered a "top tier" manager from a historical returns perspective and in this difficult environment we raised north of $3B. We don't pay nose bleed multiples for software and have been told there is opportunity for me as the firm continues to scale. Not a slow growth MF and not at an unestablished LMM firm rolling up sub $5M EBITDA landscaping businesses. 

Do I just go to a pod shop now so I'm not poor in 10-15 years and can buy that lake / beach house or is there hope for me after all? I don't need to be a billionaire, not even close. 

I think Secondaries is going to crush it

Pension funds are constantly getting new cash inflows to deploy, no? 

If one GP has low returns, they have a problem. If all GPs have low returns, the pension funds have a problem. Pension funds are going to be significantly underfunded relative to their growing liabilities for the foreseeable future in part due to over allocating to VC/PE in the bubble and not getting the expected returns, which will drive their need for higher returns, which will drive their future allocations to VC/PE. It’s just a cycle. 

As a college student should i not try to break into PE anymore?

No one said the industry will die - however, at minimum growth will slow, and as a base case we're likely to see some declines in AUM allocated to PE. This is not cyclical - this is likely secular because the whole industry is over-allocated, and at the GP-level, the barriers to entry (i.e., starting a new fund) simply isn't there (see proliferation of GPs).

If you accept the argument that PE AUM is likely to stagnate or reverse (to an extent - capital is locked up which mitigates near-term impact), this has an outsized impact on individual careers.

PE funds more than other businesses are extremely reliant on growth in AUM to produce more jobs - as soon as funds start declining in size, firms will have 0 incentive to promote new people - and will lay off existing partners/mid-levels to right-size the carry pool for the most senior-levels. So in a flat industry -promotions/survival itself become very hard.

This is putting aside the other problem which is that as returns compress the carry is worth less and less.

And then taking a big step back - the calculus starts shifting - what is the willingness/risk tolerance to (1) grind incredible hours in an (2) industry with notably bad culture (3) while being subjected to significantly increased layoff risk at some point for (4) an amount of money that is unlikely to be materially more (particularly on average) compared to alternative career paths like investment banking and consulting (at the senior partner level) - each of which has orders of magnitudes more of senior level positions (e.g., McKinsey has ~1,000 senior partners pulling in $2-3M of cash comp+ a year vs as an example, Apollo's PE fund which as ~20 partners). 

The game isn't ending it's just getting harder, which is a healthy thing IMO.  No more "ah low interest rates everything's going up let's just buy a shit ton of businesses and sell to the greater fool" -- looking at you software / tech PE big brains :)

Folks above summarized it very well. From a more personal side of things, it definitely does feel this way based off my experience at a MF and friends at other funds. VPs back from B-School no longer are guaranteed partner track like the early 2000s and even making that Principal promote is not even close to guaranteed anymore - they seem to clearly be feeling the pressure to an extent prior “cohorts” of these levels haven’t. Have heard them mention these dynamics as well. Same story with Principals - Competition is sky high with Partners still in their 40s and at least 20 more years of work left in them before retirement. There are simply less spots left in aggregate and you’re competing against some of the sharpest most intense/competitive people (especially in UMM/MF). Not to say folks in banking / consulting aren’t sharp - because they certainly are - but the average VP at a MF is levels above the average VP at a BB and it’s not even close. 

Adding on top of that struggling 2020-2022 vintages across nearly all funds, along with aforementioned secular headwinds, its hard to be excited about the PE thesis over the next 10-20 years in aggregate (again, no one is saying PE is dying entirely or that there won’t be well performing funds). 

Zero regrets going to PE because it was always to learn about investing (rather than the objective being just to make partner), but if i were to choose a career solely based off risk/difficulty adjusted earnings, PE would be nowhere near the top of my list. Especially with banks offering fairly accelerated paths to VP/director these days, or consulting having a fairly easy path to senior level (again, it’s objectively VERY difficult to make MD in banking/consulting but i’m talking in relation to PE), it truly just doesn’t make sense.

In short - yes the bubble is deflating and I think it’s pretty clear. Anyone who disagrees probably also thought there was no valuation bubble during  2020-2022 haha. But no one within PE will talk about this openly (unless anonymously on a WSO forum lol) because the air of PE is one of saving face, secrecy, and pretending your own life, your investments, your firm, and the broader asset class is always doing amazing :)

If that is truly the case, and music is already stopping
Then what is y’all advice to someone just starting out in the industry/ career in general?
Will the pay stagnate/ roles decrease and more stagnation in upwards trajectory?
Where sector will be PE 2.0, probably the most risk-averse career to make deca to centi million NW let alone billionaire founders/ partners?
Will the days of senior most partners at MFs and LMMs getting 7/8/9 figure paydays ( if at all someone reaches that level) be non-existent ?
Or will the larger prominent chunk just take out all the smaller players and make still same at lower working capacity?

The PE bubble isnt bursting.  The industry is just maturing. This is econ 101.  Growing $ AUM demand for companies, relatively static  supply of companies --> declining returns and more value creation to offset declining returns.  While the money you can make in PE is less than the early days, its still better than many if not most alternatives.  Until its not, you'll still see more PE firms, more PE professionals, more AUM.  That day is still pretty far away.

Agreed. Although i think its more nuanced. We see lots of mid-market funds in Europe struggling to raise their next fund. 

The LP investments now seem to focused on mega funds that are 8bn+ and the sector specialist or specialist strategy mid-market funds that have angles. LPs are simply being far more selective on deploying their capital.

The days of generalist multi sector mid-market funds of 2-5bn are numbered.

Just my observations as a sponsors banker.

What about the PE outlook for the real assets sectors like energy?
Does this lead to headwinds for their fundraises?

As others have mentioned, PE is a cyclical industry. It will ebb and flow with a cycle, much like IB. However, there are a few important differences I will note below. The simple truth is the hedge fund space and PhD/academia largely finds PE professionals to be an absolute joke. The trade is rife with fundamentally dishonest and disgusting practices from an academic asset allocator's perspective. The lack of mark to market of private valuations means PE firms are given substantial flexibility in reporting that allows for return smoothing and unobserved volatility that they claim is not there, however, anyone with public market experience looks at PE and is like "Ha, yeah that's not true". The industry claims it does operational improvements, but at it's core it's just a levered bet on a company in an era where borrowing was cheap and multiples expanded. The industry will continue to exist due to reasons below, but the PE and private credit world is in for a rude awakening when we hit a cycle. This forum will be stunned like it was in '08. The people being bullish just because it hasn't happened yet are moronic. We haven't seen a cycle since '08--you going to also claim we won't have another recession? Furthermore, we haven't seen PE with high interest rates until recently and as this post suggests anyone with a brain knows portcos are now struggling and transactions are slowing. PE with higher than expected rates and a slowing economy will get ugly real quick. First the tailwinds:

Tailwinds:

• Asset allocators enjoy the volatility laundering. If you hold a stock, every day that stock moves around and it makes your portfolio look jumpy and people don't like this. If you add leverage to that stock, it becomes even more jumpy. As a result, many would be very averse to having levered long equity exposure as an asset allocator. The daily volatility and monthly, quarterly, and yearly changes would make an asset allocator look like they weren't doing their job and would have the employers of that asset allocator stating they were bad at their job. Enter private equity! An asset class that gives the return of a levered equity, but based on the marks provided by the PE firm to the asset allocator, the volatility is substantially less. This is clearly bullshit. If I told a PE firm to firesale their assets, their marks would be fractions of what they state they are. Your marks should be what the market would pay today for your asset, not the average multiple of public comparibles or the recent transaction of a company much larger than the one you own. There is empirically supported return smoothing going on and documented and well known tricks to manipulate IRR like subscription lines of credit, NAV loans etc. PE would be like if you gave me $100, i took out a loan for $100 then invested $200 in the stock market. Then I said, I will pay you back in 5 years, but I have an extension clause, so I can make it 7 years if I want. Then if in year 7 the market is bad, I can borrow from the bank and use a NAV loan or a continuation vehicle to kick the actual return of my exit to year 10. Then along the way in good years I under report my return to have a cushion for the bad years making it seem like my fund just goes gradually up each year. The bottom line is the firms have extreme slight of hand and ability to obfuscate returns to the point that even the firms themselves don't actually know their returns (they can't otherwise its fraud, and frankly they don't care because they make money on management fees and the exits). In order to really understand the returns of PE, you need to adjust for time, leverage, and level of risk, which the ladder can become subjective to a degree and complicated to the point that many are unable to understand what is happening. Is a good benchmark for PE the S&P? Is it NASDAQ? Is it tech companies in the Russel? This is all a long way of saying, asset allocators being able to take more risk than they are actually showing is a feature to the allocators. It makes them look like they are getting great returns, while being conservative, when they actually are being grossly irresponsible.
• FOMO The key play of the last few decades was switching fixed income allocations to private equity. The reason is many key decision makers and asset allocators who weren't super academic were able to put forth this higher return and less volatility narrative. Unfortunately, this got put on steroids in the last few years. See when one guy does it, it's fine, but when all your colleagues and competitors begin posting higher returns than you and we haven't had a cycle, you have no choice but to join the crowd and also lever up otherwise your portfolio will do worse and eventually you will be fired. Asset allocation should be done on a multidecade horizon; however, the managers are evaluated on quarterly or annual horizons. If Harvard massively underperforms Yale for 5 years, people will start asking questions if the allocator is good at his job or if he should be fired. The point is the zero interest rate, no risk world, had everyone moving to risk on and eventually even the prudent investors had to go risk on otherwise they would get fired. This sentiment will still exist even if PE has a reckoning. Hiding returns and taking extra risk is just too tempting for people to ignore and unless there is major regulation, asset allocators will always want PE to hide returns. Also, there is some legimate case that some private companies really do do well (ultimately, it is like equities and good companies do exist! A PE firm can actually acquire the private company version of NVIDIA. So regardless of what happens there is a place for buying private companies.

Headwinds:

• Overly Mature: Everyone and their mother has raised a fund or tried to. When IB processes have hundreds of buyers all looking at CIMS and it is a bunch of people evaluating these companies who have undifferentiated experience, someone is bound to overpay. Further, when PE partners make money off the amount of assets they manage and get in pissing contests they compete to raise more and more capital for the asset class. This results in PE professionals scrambling to win deals to deploy capital to justify their firms existence. This does not end well. The winners curse is real. There comes a point where if you pay too much for even a great company multiple contraction will harm your returns for even the best company.
• High Leverage: The leverage piece of this puzzle is important. Things only really blow up due to leverage. Not all, but many firms out there are getting a little too tricky with the financial engineering and how much leverage and risk they are taking. As mentioned, things like subscription lines of credit, NAV loans, continuation vehicles, and retail investor funds, are starting to get very Ponzi scheme like. Borrowing from peter to pay paul only works for so long. The high amounts of leverage and many players mean there are going to be some really dumb players who bastardize the business model and create horror stories that will draw media attention and fear of the asset class.
• Market Sentiment: Once the asset class falls out of favor scrambles can happen. Much like a bank run, people can get irrationally panicked. PE is currently the golden child of MBA programs, Pensions, Endowments, and even individuals--it can only go down from here, and there are plenty of signs its starting. Top story on bloomberg a few days ago was the following: https://www.bloomberg.com/news/features/2024-08-06/why-prospect-capital-s-8b-private-credit-strategy-is-raising-concern It is already happening. If you talk to asset allocators many now want their money out of PE funds and can't get it out. This is going to stunt LP fundraises. 
• Regulation: The field has too many wealthy people to not be blamed for a cycle eventually. Everyone knows the narrative that PE firms slash costs and cut employees and make products terrible, but we are getting closer to claims of large PE firms violating anti-trust issues or importantly their leverage being blamed for a downturn. In a downturn, main street and individual people will be angry and the arrogance and high earning professionals of private equity that didn't allow many retail investors access when they made great returns then screwed up their pensions when things went south will be the target of political hate.

The jenga tower hasn't fallen, but its wobbling. It might still wobble for a few years and the base of the tower will still exist, but the private equity industry we see today is going to get regulated and crushed. Some of you will say it will be gradual, but again, my experience says there are too many people in the industry and leverage is too prevalent to not have some jarring blow ups. These blow ups will be a shit smear that will show what PE actually is: rich people playing with leverage. Good news is it will come back, it just will look different.