Private Equity's New Rules

“Arctos tracks 6,000 private equity firms in the US and Europe who raised institutional capital in the last seven years. They organize these into 10 levels defined by size, product breadth, asset class coverage, capabilities (local vs. global), public currency, balance sheet, wealth distribution, and captive insurance. Only 6 firms are level 10 (Ares, Apollo, Blackstone, KKR). Level 9 has 10-11 firms. These 15 firms (0.2% of universe) control 20% of AUM.”— Ian Charles

Strategy & Decision Making · Business & Entrepreneurship

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10-level taxonomy; level matters more than strategy

“The new rules set over the last four to five years create a framework where sponsors are reluctant to sell to each other. When they can, using a continuation vehicle to hold an asset grows their fee-related earnings and creates inorganic AUM growth, which is a powerful incentive, especially when you're not sure the old rules apply. The old rule was: deliver a great exit to LPs and they'll roundtrip that money to support the next fundraise.”— Ian Charles

Strategy & Decision Making · Economics & Markets

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CV incentives break sponsor-to-sponsor trust

“Distribution yield is even worse than it appears because 15-20% of all exit activity in the last two years has come from inorganic transactions: continuation vehicles, NAV loans, and similar activity. If you just look at distributions from traditional exits (IPOs, M&A, sponsor-to-sponsor), the yield is actually worse. Four ingredients are needed to get yield back to normal: (1) accommodating macro (we're in it now, in the Goldilocks zone), (2) intrinsic value (PE is still overvalued by 10% vs.”— Ian Charles

Economics & Markets · Strategy & Decision Making

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Four factors for yield recovery; still overvalued

“Distribution yield is what matters to the LP, not dollar value of distributions. It's distributions relative to their unrealized book. The yield of private equity today is as bad as it's ever been, bottom quintile. Over the last 10 years, dollar distributions have been consistent at about $40 billion a quarter out of North American buyout, except for the 2020-2021 bulge. Ten years ago, drawdowns were $20 billion a quarter, creating nice net cash flow yield.”— Ian Charles

Economics & Markets · Business & Entrepreneurship

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NAV tripled while distributions flat; yield crashed

“The higher the skill level in a competitive game, the more luck determines the outcome. If you took an average major league baseball player today and put them in the 1950s, they'd be a Hall of Famer. The same is true in asset management. The more competitive the game, the higher the skills required to compete, but the higher the skill level, the more luck comes into play. The same pattern holds as you move up in levels within the PE framework.”— Ian Charles

Strategy & Decision Making · Psychology & Behavior

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High skill convergence amplifies luck's role

“Last year, the six biggest LPs in North America committed about $55 billion to funds. The six biggest private banking and wirehouse platforms committed about $110 billion, twice the LP number. In the last 12 months, level 10 firms have raised $250 billion from insurance companies they control or through the wealth channel with sales forces that are theirs. They don't have a capital origination problem. They have a deal origination problem. For everybody else, capital is constrained.”— Ian Charles

Economics & Markets · Strategy & Decision Making

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Wealth channel 2x traditional LPs; level 10s raised $250B

“A level five firm is single strategy, best-in-class. Very good at what they do. Content to come back to market every 2-4 years. But because of market changes, you now have to put energy into managing the business just to maintain your level five position. The market is changing, the client is changing, the competitive landscape is changing in ways that require you to level up capabilities even if you just want to stay where you are.”— Ian Charles

Strategy & Decision Making · Operations & Execution

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Staying put requires running faster

“The organizational complexity is non-linear as firms grow. The capital required to grow is significant. One challenge: do you have a right to win in the direction you're going? Do you have the skills in the six or seven areas that are critical for these businesses? A distribution head from a great firm said he wished he had seen this framework six to seven years ago: 'It was all about going from level six to level eight, but no one knew why. We lost ourselves on the way to level eight.”— Ian Charles

Strategy & Decision Making · Leadership & Management

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Growth without purpose destroys identity

“Arctos has proprietary software for isolating and estimating alpha generation. It's a collaboration with the manager using very detailed data. The process diagnoses skill versus luck, then disaggregates performance across every strata: industry, deal partner, size, geography, product. First question: have you generated enough alpha to justify taking illiquidity from the client? Many firms' answer is no. For those with significant positive alpha, where does it come from? Do you buy well?”— Ian Charles

Business & Entrepreneurship · Strategy & Decision Making

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Disaggregate returns to find skill pockets

“After the GFC, there was a wave of zombie firms: hadn't raised money, weren't going to earn carry, lots of value trapped. That's not what we're talking about now. There is tremendous unrealized value and unrealized gain managed by really talented people, and the firms they're part of are going to come to market in the next 12 to 24 months and will not achieve the fundraising target they need to feed all the ambition and mouths at that organization. They're not zombies.”— Ian Charles

Economics & Markets · Strategy & Decision Making

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Not zombies; penguins on melting ice

“There are firms with founder-centric architectures and firms that started as spin-outs from big financial institutions. In a spin-out, there's less founder mentality, more stewardship. If the firm started with that architecture, generational transitions tend to be more seamless and stable compared to founder-centric firms. You can measure founder centrality mathematically by scraping LinkedIn data. Arctos supported academic research on using network dominance to predict venture fund performance.”— Ian Charles

Leadership & Management · Technology & Engineering

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Network growth rate predicts succession success