By Joel Kranc
Economic and market volatility remain top of the fold headlines as inflationary pressures, COVID and the war in Ukraine are showing no signs of letting up any time soon. For institutional investors with longer-term investment horizons, the market has never been just one thing. Private equity and venture capital have played important roles in large investment portfolios. But the tides are turning and as volatility continues, it is seeping into private equity markets as well.
Earlier this fall, for example, it was reported that Canadian pension fund manager PSP (Public Sector Pension) Investments was looking to sell about C$2 billion of its private equity stakes.
In October, Jo Taylor, president and CEO of Ontario Teachers’ Pension Plan told Bloomberg that the C$243 billion fund will boost its exposure to bonds, given current attractive yields. Finally, C$539 billion Canada Pension Plan Investment Board (CPPIB) CEO John Graham, in an interview, said the fund has been active in the public equity space. “We’ve been doing more public than private because we just see more value right now.”
What’s going on with these (and other) large investors?
“Over the past two years fundraising was crazy,” notes Sheila Ryan, investment managing director with Cambridge Associates. “But the slowdown in 2022 has been notable.”
She says there is a lot of confusion around private equity valuations given that public markets are falling and private markets have not yet fully adjusted. As a result, sellers are probably hanging on to expectations to get what they might have sold a business for a year ago, for example. This is leading to a disconnect between buyers and sellers as to what the right valuations should be.
Ryan also explains there are even more challenges for the buyers when it’s difficult to predict and forecast EBITDA or revenue given the uncertainty around a global recession or inflation. This could be a trend for some time.
Brian Kobus, is Managing Partner with OMERS Ventures in Toronto. He tells CAIPforum: “As the pace of deal making accelerated leading up to, and during the pandemic, many GPs came back to their LPs (including their pension fund LPs) raising larger funds and deploying those funds more quickly than they had in the past. This led to an overall increase in allocations to venture capital by many pension funds. Now that the pace is slowing, many pension funds are slowing the pace of commitments to venture capital funds, which in turn is causing the underlying funds to slow their pace of deployment.”
In fact, private equity is on track for sluggish growth over the next five years as inflation and macroeconomic uncertainty take their toll on investments and investors shift capital to lower-risk asset classes, a new report from Preqin Inc. predicts.
Preqin says expansion of assets under management for the global private equity industry, will total $7.6 trillion by 2027. That would represent an 80% increase from the industry’s collective AUM today, which the report estimates at $4.2 trillion.
The forecast relies on an annualized growth rate of 13.5% between 2021 and 2027 — a significant slowdown from the 15.4% annualized growth Preqin estimated for private equity from 2015 to 2021. “Overall, our forecasts suggest that the sweet spot that private equity markets have enjoyed over the last few years is likely over,” the report noted.
This will likely continue, as rougher macroeconomic conditions will also lead private equity fund managers to hold onto portfolio companies longer, slowing the pace of exits and the distribution of returns to investors. That, in turn, ties up capital that could otherwise be reinvested in new funds, the report explained.
Ryan says that for the time being some institutions will “hit pause” and/or punt private equity investment decisions into next year and beyond. It is also likely that there is activity in the secondary market as selling increases by institutions, and some may even be increasing their target allocation to reflect the fact that they’ve already hit their previous target but are changing it to reflect new realities of being “over allocated.”
Finally, reallocating funds to private credit (which sometimes comes from hedge fund assets or fixed income assets) is appealing because of interest rates and spreads increasing, which have bumped up unlevered returns.
In the meantime, it appears investors will likely wait for some stability to materialize in the public markets to allow private markets to catch up.
