Private equity firms such as Blackstone Group LP (BX), The Carlyle Group LP (CG), Bain Capital LP and KKR & Co. L.P. (KKR) have generated robust returns of up to 14% per year by lending money to small and midsize companies, according to The Wall Street Journal. While this particular segment has represented one of the hottest areas in private equity, its returns have been dwindling as competition rises and interest rates for loans made to smaller businesses push lower. 

This area has been facing deteriorating returns at a time when the broader private equity industry has been struggling to generate satisfactory returns, Pensions & Investments reported. Many firms in this particular sector are failing to outperform their respective benchmarks, giving some market observers concerns about private equity in general. (For more, see also: What Is Private Equity?)

Stalling Momentum

Over the last several years, private equity firms have been highly successful at raising money for funds aimed at lending to small and midsize companies, drawing nearly $120 billion from investors in the four years ending in 2016, according to Preqin figures reported on by the Journal. This figure is more than 400% higher than the $22 billion that these funds raised in the four years prior. However, this sector's momentum appears to be slowing down, as private equity firms have raised only $11.9 billion so far in 2017 for these funds.

 

 

Dwindling Returns

In addition, returns have been moving lower as well, according to the Journal. While private equity funds of his kind raised in 2008 produced annual returns of 14.2%, funds raised in 2010 and 2011 generated lower returns of 10.4% and 12.3%, respectively, additional Preqin data shows. While private lenders had greater opportunity to offer credit to small and midsize companies as regulatory constraints became more stringent following the financial crisis, competition has been placing downward pressure on interest rates. (For related reading, see also: Small Business Financing: Debt Or Equity?)

New York-based private equity firm MB Global Partners, for example, was able to command interest rates of more than 15% following the financial crisis, founder Maria Boyazny told the Journal. In addition, the private equity firm was able to negotiate strict lender protections referred to as covenants. However, borrowers now have enough leverage to secure loans that have interest rates below 10% and lack these safeguards. 

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.