Private equity in 2019 will be insulated from the economic and political uncertainty that may harm... [+] other investments. Photocredit: Getty
Getty
Based on market trends and investor sentiment and how the two intersect with an uncertain political and macroeconomic outlook, private equity should have an amazing year. These 10 predictions illustrate private equity’s resilience amidst stock market volatility, trade wars and Brexit battles. Far from crimping performance, such challenges will increase private equity’s appeal in 2019, particularly versus other forms of investment.
Commitments to Private Equity Break Records
The $703 billion commitment flow to private equity in 2018 - $514 billion pledged to classic funds, and a record $189 billion devoted to co-investment, separately managed accounts and direct investment - stands 12 percent below 2017’s record of $800 billion and 3 percent shy of 2016’s runner-up total of $722 billion, according toestimates from Triago, the fund advisory I founded 26 years ago. But the high annual commitments of the past three years pale in comparison to what 2019 holds. Expect more large fund offerings than ever before, an unprecedented number of total funds seeking capital and new highs for co-investment and separately managed accounts, as private equity managers rush to lock in record commitments before one of the world’s longest periods of economic expansion comes to an end.
Private Equity Outperforms Stocks
The average private equity fund appreciated 8.2 percent in 2018, while virtually all major public market indexes experienced double-digit annual declines. Private equity assets, actively managed by fund managers and not subject to the more extreme valuation swings of the stock market, tend to outperform public equities during periods when the latter are hit by exceptional volatility. The macroeconomic and political concerns that lead to volatility in 2018 remain with us and private equity will continue outperforming stocks this year, attracting growing numbers of investors.
A Large Generalist Asset Manager Acquires a Leading PE Manager
Some will say I’m going out on a limb with this one (to see truly against-the-odds predictions, check out my satiric“Outrageous Predictions for 2019”). Yet with the global economy seemingly moving closer to downturn and with traditional asset management profit squeezed as public market investors move from high-margin actively managed strategies to low-margin index investing, push is here to shove. Although private equity is the only asset category remaining where active management produces better returns than passive index investing, this landmark acquisition will happen amid a general move towards PE consolidation that is already underway; private equity appetite is experiencing secular growth, but the number of funds seeking capital and the amounts being sought have been rising even more rapidly.
The Largest Buyout Fund Launches
Exceptionally large buyout funds have been raised in recent years and the one with the biggest target yet will start raising in 2019. The following, noted inlast year’s predictions, still holds true: investors are eager in a low-interest rate world to invest historically large sums in PE funds whose past iterations produced high returns. Given the fund performance track records and stated fundraising targets of the world’s publicly-quoted mega fund groups, along with the inevitable pressure to raise while good market conditions last, this prediction is an odds-on favorite. The record to gun for is the $24.7 billion raised for Apollo Fund IX in 2017.
The Debate Over Retail Investment in Private Equity Kicks into High Gear
The U.S. Securities and Exchange Commission intends to issue a so-called “concept release” in coming months seeking broad comment on how to update capital raising. One of the issues that SEC chairmanJay Clayton wants exploredis access to PE investment for retail investors who fail the current wealth-based hurdle for private placements. From Clayton’s public statements it’s clear that the SEC believes PE could open up high quality, potentially high return investments for U.S. individuals with some $17 trillion in IRA accounts and defined contribution retirement funds. Given the attitude of Clayton and the eagerness of leading fund groups to open up private equity investing to individuals, we should be close to new rules permitting retail investment by year-end.
The Secondary Market Registers a New Volume Record
Last year set a record for the sale of investor stakes in closed private equity funds, with $66 billion traded on the secondary market, topping by 47 percent the previous 2017 high of $45 billion. Driven by record amounts of leverage (loans, deferred payments and preferred equity), equal to 38 percent of secondary volume in 2018, not to mention $129 billion in unspent equity earmarked for secondary investment, the market for used PE funds will set a new volume record in 2019. Adding to rapid growth are investors eager to capture high prices ahead of a possible economic downturn. The average price for a series of mostly high quality funds sold on the secondary market over the last six months of 2018 - with over half the vehicles sold in the fourth quarter when stock prices were falling - was 102.5 percent of net asset value, according to a study conducted byPalico, the online private equity fund marketplace I founded in 2012. That represents the highest six-month pricing Palico has ever recorded.
Non-Traditional Buyers Account for a Quarter of Secondary Market Deals
The rise of non-traditional buyers is also contributing to high secondary market pricing. In 2018 they accounted for 22 percent of secondary market transactions by number, up from 4 percent a decade earlier, according toPalicoestimates. They include family offices, insurers, sovereign wealth funds, endowments, foundations and pension funds, all historically focused on primary fundraising, yet increasingly drawn to secondaries. The appeal of buying secondaries is a shorter time frame for investment distributions and less risk than in primary investing, where capital is committed to a blind pool rather than to a portfolio of assets that can be analyzed. While specialists – mostly secondary funds and funds-of-funds - focus on current net asset value, near-term liquidity and buying at discount, non-traditionals put a greater accent on potential appreciation. That frequently means premium pricing. Given current trends, they should account for a fourth or more of all secondary transactions this year.
Single-Asset Secondary Transactions Rise to a Record $14 Billion
General partner-led secondary deals - restructurings permitting the collective transfer of long-in-the-tooth fund assets from one group of investors to another - rose to a record $22 billion, or a third of secondary volume last year. That nearly doubles the former high of $12 billion in 2017. Interestingly, the fastest growing portion of GP-leds are single-asset secondaries, where GPs arrange the full or partial sale of just one asset. Such transactions increased to $7 billion last year from $3 billion in 2018. GP-leds give managers more time to create value, often by investing new sums, while providing full or partial liquidity to limited partner investors who want out. Single asset deals, which are comparatively simple to arrange, will more than double in value this year, outpacing the growth of more difficult to arrange multi-asset or entire-fund GP-led deals.
Politically Motivated Strip Sales Move to the Fore in 2019
Politically motivated sales of assets is yet another factor I’m predicting will lead to a significant increase in secondary volume in 2019. Intensifying political battles, whether tied to the trade war between the U.S. and China, or to Brexit in the European Union, are likely to add to secondary volume in 2019, both for traditional stake sales between investors and for GP-led deals. With Britain likely to be lashed by Brexit inspired uncertainty for some time and with China’s already slowing economy burdened by the specter of a widening trade dispute with the U.S., the value of secondary deals for U.K. and China-based private equity portfolios alone could rise into the tens of billions of dollars.
Private Debt Funds Will Keep Credit Flowing in the Event of Recession
This prediction has a big caveat: it only happens in the event of a recession. But since that’s an increasingly legitimate worry for many, I’m including it. Private equity managers looking for bargains in downturns have been frustrated by a lack of available debt. But since the global financial crisis, private debt funds have displaced banks as key lenders to small and midsized enterprises, the main investment area for PE’s debt-fueled core: buyouts. The assets of debt funds, which extend 83 percent of their lending to SMEs, have risen three-fold in a decade to $666 billion and will increase to$1.1 trillionby the end of 2020, according to the Alternative Credit Council. With so much firepower held by fast-growing “use it or lose it” funds that are unrestrained by banking regulations, and with so many of these vehicles controlled by buyout specialists, credit should flow liberally for many private equity deals in the next recession.
To see last year's predictions, pleaseclick here.
