megatrends
Private Equity Enters a New Phase
The New Dynamics of Private Markets
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For many, the term private equity is still synonymous with spectacular corporate buyout deals. And while leveraged buyouts (LBOs) remain the largest segment, private equity markets have grown exponentially over the past two decades and now include much more – such as direct real estate, infrastructure equity and secondaries.
$1.2 TRN
Total AUM of real estate private equity funds
trends that will shape the private equity markets
permanent capital
FROM LPs TO GPs
Portfolio Management
leaders Pull Away
FROM LPs TO GPs
leaders Pull Away
permanent capital
Portfolio Management
Private equity leaders separate from the pack as dry powder and deal size hit new highs
With a record $870 billion available to invest, deal sizes are rising across the PE industry. The trend toward scale is apparent across the private equity landscape.
Private equity returns are highly dispersed
Source: Pitchbook and eVestment
Note: Internal rate of returns for PE funds of the vintage 2004 to 2017 as of December 2021. Public large-cap and small-cap represent US mutual funds of the same category, respectively.
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Investments in private equity go well beyond LBOs and include direct real estate, infrastructure, and secondaries.”
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A shifting paradigm for private markets
Private Equity Enters a New Phase
Portfolio Implications
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Secondary markets are an essential rebalancing tool for investors
As the primary private equity market has matured and its share in institutional investors’ portfolios has increased, it has created a need for liquidity and strategic portfolio management.
LARGEST INSTITUTIONAL INVESTORS ARE TRANSITIONING FROM LPs TO GPs
Institutional investors with heavy allocations to private markets are increasingly looking for ways to reduce their fees, through direct and co-investments. These deals are a departure from the traditional PE fund structure, where the general partner raises capital from a handful of limited partners, usually institutional investors, with equal rights and obligations.
Private equity firms are seeking more permanent sources of capital
While institutional investors are the main source of this patient capital, PE firms are increasingly looking for alternate pools of permanent capital. This would reduce their reliance on perpetual fundraising and potentially allow them to invest in assets with longer payback periods.
Source: Greenhill Cogent, Global Secondary Market Review H1 2022
Secondary markets are increasingly GP-led
Total GP- and LP-led transaction volume, US$ Billion
Performance of top and bottom quartile funds since 2004
Private credit expands its reach
Private credit expands its reach
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The dispersion of returns within PE highlights the importance of manager selection – the top quartile of funds generates investment returns more than twice as high as the bottom quartile.
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For LPs, the secondary market has proven to be an effective tool for managing their growing private equity portfolios.
Investment implications
Discover investment risks and opportunities across private equity.
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Private Equity Investment Implications
1. Secondary markets create new flexibility and opportunities
In addition to creating liquidity, secondary transactions provide a portfolio management tool to implement a change in investment strategy or dampen the J-curve of primary funds
Secondary markets can create opportunities for buyers who can provide liquidity in times of market uncertainty and elevated discount to net asset values
2. Closely monitor PE fund practices and structures
Restructuring and continuation funds involve value transfers that may create potential for misaligned incentives between GP and LP that need to be evaluated
If misused or undisclosed, subscription lines can distort performance metrics and be a source of embedded leverage
3. Reconsider the role of Venture Capital
VC risk-adjusted returns have lagged other private market strategies since the early 2000s.
However, CIOs can benefit from the vision and market intel of VC management and portfolio companies to identify potential vulnerabilities and targets of disruption in other parts of their portfolio
4. Renewable and digital infrastructure provides global opportunities
As renewable power ramps up, there are opportunities in adjacent areas such as energy storage and low-carbon hydrogen
Hyperscale data centers – large-scale facilities that cater to the biggest cloud providers and tech companies – offer attractive investment opportunities globally
Investment implications
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Venture capital is at the point where unicorns are no longer mythical but rather mundane.
In LBOs, deal size has more than doubled from $48 million in 2011 to $101 million in 2021.
Increasingly, sponsors themselves have become a significant part of the secondary market. These so-called GP-led transactions more than doubled over the past five years to almost 50% of all secondary volume.
These attractive terms come at a heavy cost – they require significant investment of capital, a high conviction in their PE partner and considerable in-house talent to directly manage the investment and its accompanying risks.
These deals are structured with institutional investors as equal partners – or sole investor – giving them the potential for higher net returns (through lower fees).
One is to directly acquire or partner with an insurance firm. The mergers of Apollo and Athene or KKR and Global Atlantic are good examples of this.
A second option is to employ permanent investment vehicles – rather than the classical closed-end funds that typically have a time horizon of eight to 12 years. Increasingly these vehicles are also targeted at HNW and affluent individual investors.