Dry Powder in Private Equity: How Does It Relate to Performance and What Are the Implications for Investors?

Abstract: Although average returns are decreasing in the PE industry, fund sizes are increasing more than ever, as more and more capital is poured into the industry. The amount of uncalled capital, known as dry powder, has recently hit record-high levels. This paper aims to invest how the return of PE funds correlates with the amount of dry powder left at liquidation. The hypothesis is that there may be a tendency among managers of the fast-growing PE funds to invest close to all committed capital either by pursuing extra projects or by spending it on trying to save failing ones - even though it may have been optimal to do neither one of them. Using an OLS-regression test, we test how the IRR to limited partners correlates with dry powder left at liquidation. We also test how different strategies for deploying dry powder could affect the return. Our results show that the final IRR to limited partners correlates positively with the amount of dry powder left at funds' liquidation. Furthermore, we find no correlation between the IRR and the number of investments pursued. Results are significant on a 0.1% level when controlling for size, industry, strategy, and year. The results show that funds with more dry powder left at liquidation have had a stronger performance than those with less and that the number of investments does not affect return to investors. This indicates that funds who have deployed all committed capital may have done so either by paying too much in acquisitions or by trying to save failing investments, resulting in a lower IRR.