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IN THE NEWS

🧟 Private Equity’s Slow Carnage Unleashes Wave of Zombies

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Investors and regulators have a new name for private equity’s laggards: zombies.

Private equity (PE) might have a desirable name with high-paying jobs, but the $12 trillion industry isn’t performing as well as you’d think. A new Bloomberg report has found that hundreds of private equity firms are running on what we can call “old money,” with no new fundraising.

Say what? In short, fading money managers aren’t raising fresh funds. Pension funds have hit their limits in how much they devote to private equity as they move to cash to fetch higher rates, another consequence of higher interest rates after years of declining interest rates.

Houston, we have a problem. The private equity industry is on track to raise 28% less than last year.

• As Bloomberg puts it, “(Private equity) firms that failed to build fresh war chests during the recent boom years of low interest rates are now finding it difficult to arrange fresh funds.”
• Said one money manager: “This is the market where you could see several zombie funds emerge. When things go sideways, it creates a downward trajectory.”

If money managers don’t start new funds, they can lose employees, leaving a skeleton or “zombie” team behind them.

All sorts of headaches: PE funds usually intend to last about 10-12 years, tops. But many go long past their expiration dates, creating headaches for clients deciding whether to leave or hang on.

Why it matters:

Wait, it gets worse: According to reports from 10 big public retirement systems, a median 4% of their private equity portfolios are in funds established before 2009. That amounts to $6.8 billion invested in over 900 funds, some of which go back to the 1990s.

For example, Fenway Partners was once a giant with offices overlooking Manhattan and Los Angeles. Now, it has just a three-person team that manages what’s left of a small town in Rhode Island. That’s a zombie fund.

• Fenway hasn’t raised a new flagship fund since 2006, and its primary asset is a 20-year investment in Riddel, the football helmet maker embattled with lawsuits over concussions.
• Delays of several years are now typical in the sector. Private funds that began operations before 2010 still retained almost $80 billion as of last year, and since the beginning of 2015, 645 businesses have not raised a new buyout vehicle.

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😎 U.S. Companies Get Creative to Counter Rising Interest Rates

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Companies are cruising away in convertibles. No, not those convertibles ^

Rather, companies are turning to convertible bonds, hoping to reduce the sting of higher interest rates. See, convertible bonds are the shape-shifting Corvettes of the otherwise plain corporate debt world.

Most bonds are straightforward: You need money, so you issue IOU coupons with interest in exchange for money today and pay back those debts over a defined period.

• But convertible bonds double as bonds with the potential of converting into stock if a company’s shares reach a certain price.
• Because of this optionality, companies can issue convertible bonds at lower interest rates than they would otherwise get.

Big fish in a small pond: The convertible bond market is typically the domain of more speculative — often tech — companies focused on growing very quickly (for example, several years back, the U.S. convertible bond market was dominated by Tesla.)

But that’s changing, according to the Financial Times, which writes, “High-grade U.S. companies are piling into the convertible bond market…as they try to minimize rising borrowing costs caused by the Federal Reserve’s aggressive campaign of interest rate rises.”

• More established companies with ‘investment-grade’ credit ratings issued $12 billion of convertible bonds in 2023, capturing more than 30% of the convertible bond market.
• That’s the highest share in a decade and three times the average rate.

Why it matters:

For companies with among the best credit ratings, meaning they presumably are the most financially stable and worthy borrowers, they still face an eye-watering 6% interest rate on average for new issuances of bonds.

Firms in more traditional industries, like utilities, real estate, and manufacturing, are turning to the convertible bond market to lessen interest expenses.

• One Bank of America bond strategist suggested that companies could use convertible bonds to reduce their interest rates by 2-3 percentage points on average.

Of course, there’s no ‘free lunch’ in finance (as the Wall Street aphorism goes.)

Hidden costs: Convertible bonds, despite the lower interest rates, aren’t without equivalent costs. It’s just a different cost. If convertible bonds transform into shares of stock, those are new ownership stakes in the company, diluting the value of existing shares.

• Still, (potentially) diluting shareholders and making their shares worth slightly less is a more abstract cost than sending cash out the door to pay interest on debt.
• Although the pickup in convertible bond issuance is accelerating, it’s a drop in the bucket compared to the $2.3 trillion of corporate debt coming due between 2024 and 2026.

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🗽 New York’s Composting Law Could Set National Example

Photo by Nareeta Martin on Unsplash

Composting is a process largely done in the dark — with some help from fungi, bacteria, and worms — but it’s increasingly stepping into the light.

A new initiative, already implemented in Queens, mandates residents to segregate food scraps and yard waste from their garbage — Brooklyn’s next in line.

The mandatory composting law in New York City has the potential to make organic waste collection a norm in U.S. cities, mirroring the impact of the city’s 1989 bottle and can recycling program.

In the weeds: New Yorkers will be required to segregate food, outdoor waste, and food-soiled paper for universal curbside collection starting in spring 2025.

• “If you cook it or you grow it, you can throw it,” is the campaign’s slogan.
• The program applies only to residences, as NYC businesses and restaurants must use private haulers for organic waste, a requirement already in place for some businesses.

Mandatory composting laws have been passed in at least nine states, including Vermont, New Jersey, California, and Washington, and even more are running pilots.

Why it matters:

Going to waste: Composting food instead of burying it in landfills reduces methane emissions, a significant contributor to climate change. By some estimates, food waste underpins some 8% of total global greenhouse gas emissions.

• According to the U.S. Department of Agriculture, a third of food intended for human consumption is wasted, making up a large portion of landfill and burned-up waste. That adds up to more than $400 billion in wasted food annually.
• Sadly, less than 6 million American households have access to curbside composting, according to research from Biocycle.

One governmental research report from last year found that in the U.S., every $10 million invested in composting facilities supports twice as many jobs as landfills and seventeen times more than incinerators.

• The study also showed that composting was economical since it helped cut waste-hauling fees by $700 per ton of waste.

While composting initiatives are promising, adoption is slow. Decades after the push to recycle began, national recycling rates sit at just 32% — the U.S. Environmental Protection Agency (EPA) aims to increase that to 50% by 2030.

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See you next time!

That’s it for today on We Study Markets!

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