LPs disagree over Blackstone megafund

The Blackstone Group’s fifth buyout fund set a record this week when it closed on $21.7 billion (€15.7 billion) – and it has LPs and their advisors sharply divided as to whether its size is a barrier or a boon.

“Who could possibly think it’s good to have a $20 billion private equity fund?” bemoans one LP source.

With funds of this magnitude, the person argued, the alignment of interests with limited partners deteriorates, because with bigger funds general partners are guaranteed bigger management fees, thus allowing the GP to become less concerned with the carry generated from returns for investors.

“The other thing is that these big funds have gotten addicted to financial engineering to generate their returns,” the LP source continued. “And that’s been great in this past cycle we just came through because the credit markets have been really favourable and let you do lots of creative things, but … I just worry that as the credit markets change and some of the tools that they’ve used over the last five years to generate great returns are taken away from them, whether they can adapt.”

The size of Blackstone Capital Partners V presumes a market similar to what the industry has seen for the past few years, and may force Blackstone to deploy capital “in periods when you shouldn’t be. And I think right now you shouldn’t be,” the source said.

Other LP sources see advantages to increased size. One noted the size of Blackstone’s new fund will enable the private equity firm to do fewer club deals, which the source says translates into “less complexity, less issues, less danger” for limited partners.

Another source noted that the debate as to whether or not BCP V is too big is irrelevant, considering it’s already two-thirds invested.

“These guys are going to be out in the next six months to raise more capital,” the person said, adding that concerns that there’s too much money chasing too few deals or that firms are more concerned with management fees than carry, and thus returns for LPs, are “red herring” arguments that have been repeated for more than a decade as funds have grown.

“Everyone always has the same argument. And one, it’s the same guys who are still plowing in and investing in the fund – so I do find it ironic – but two, show me the math,” the person said. “Have the returns dropped? Was [Blackstone’s] $6 billion fund a disaster? No – it was one of their best funds ever. What’s the basis for the argument?”

Critics of megafunds have yet to put forth a “factual argument”, the person continued.

“If you could take fund performance and show a linear relationship that as funds have grown, returns have come down, that would be a great argument – except it doesn’t exist, it’s not true,” the source said.