Good Times Or Bad Times Ahead For Private Equity?

Luxembourg-based Head of Risk Management AIFM, Adela Baho, spoke to AGEFI about her views on the future private equity.

Since 2015 the amount of bonds trading with negative yields has increased from $2tn in 2014 to ca. $16tn in Q2 2019, according to IMF and Bloomberg data. This translates into governments being paid to borrow money. At the same time, the whole yield curve is covered by issuances such as in the German market, be it Bund or covered bonds at the extreme right end of the curve. The yield curve has inverted for the first time since the Global Financial Crises (GFC), raising the odds of a recession in western economies.

Record highs are reached for buyout deals, private debt backed deals, infrastructure deals and the dry powder (i.e. the amount of committed for investments) has reached its highest level since 2000. What is more striking is not only the high record level reached but more importantly the pace at which this is happening, indicating a buoyant fundraising activity.

According to Preqin data on European Private Equity and Venture Capital for the European Market, it took 9 years from 2006 to 2015 for the dry powder level to double, with highest acceleration during the GFC period from 2008 to 2012. However, it took half that time for the dry powder to double again from 2015 and reach a pile of ca. EUR 600bn today.

What is the corollary for PE funds?

The current status of economic cycle coupled with the procyclicality feature of the investments in private equity increases the asset class' challenge to continue to provide a high level of returns. According to Preqin data, the median returns (measured by the internal rate of return (IRR)) has decreased following a drop in positive cashflows back to investors or LPs.

This holds true as well in terms of fundraising or so-called "PE activity" due to the existence of a strong relationship between fundraising and economic growth. These findings are supported not only by academia showing that investment activity and leverage levels are inversely related to credit spreads, but also by market activity. In that regard, investors were surprised by the latest decisions by two big asset managers to increase their exposure to PE investments by launching a "perpetual fund" and a multibillion open-ended fund, according to Financial Times, with the aim of reducing the level of leverage of highly indebted companies and de-risk the investments, and still be in a high-margin business. Another...