With private equity fundraising having seen a downturn in H1 2022, Ropes & Gray partners Debra Lussier, Laurel FitzPatrick and Bryan Hunkele and I examined - in this article - the driving forces behind this slowdown and how sponsors and investors are pivoting their strategies in light of shifting market dynamics.

According to Private Equity International’s H1 2022 Fundraising Report, global private equity managers across private capital asset classes raised US$337 billion in H1 2022, down 27% from H1 2021 levels. What is causing this contraction?

The denominator effect. With public equities falling throughout the year, some investors are finding that their portfolios are over-allocated to private equity. This has caused investors to pause and reassess their deployment plans.

Record-sized funds raised by blue-chip managers. The high number of large funds closed this year, including by blue-chip managers Advent International, KKR and The Carlyle Group, means that LP allocations for 2022 are already stretched.

A decline in exits has caused a slowdown in distributions from managers, leaving LPs with less cash to redeploy for new investments.

As a result of this squeeze on LP capital, investors have been pivoting toward larger, more established managers. According to Pitchbook, funds targeting US$5 billion or more accounted for 58% of capital raised in the U.S. private equity buyouts market in H1 2022. This has made securing LP attention and capital a challenge for mid-market and emerging managers, which have had to bring innovative and flexible fundraising structures to market to secure investor support.

The changing risk outlook and impact of rising interest rates are also shaping the fundraising landscape from a strategy perspective. Anecdotal evidence suggests that investor appetite is increasing for strategies that are viewed as offering more stability, such as private credit, infrastructure and real estate, in an inflationary environment. Distressed debt is another emerging strategy.

Managers are also adjusting to working with larger groups of LPs to fill increasingly larger funds and rising investor demand for more bespoke reporting. Cultivating new relationships and bringing new LPs into a fund are contributing to longer fundraising timelines and making negotiations more complex, with the inclusion of side letters becoming more commonplace.

In the end, appetite for private capital remains durable and managers are still getting funded, even if it is taking longer than in prior fundraising cycles. The window for new commitments may open up again next year.