InsightsChart of the Week

Crisis Selling

In times of financial crisis, the public equity markets generally sell first and ask questions later. As a result, good companies, with lower risk to the new economic environment, can become oversold along with higher risk companies.  

Private equity historically holds assets through choppy macro periods and downturns, thus typically isn’t a forced seller when markets correct. And because GPs know that they will likely ride through an entire economic cycle with their long-term equity positions, they tend to focus on buying companies that can make it through a downturn.  

These charts show PE Buyout valuations outperformance relative to public equity during crisis selling. The question for the current market is, “How far will the global stock markets bounce anotend can its return surpass that of private equities?” Regardless, on a risk -adjusted basis, where would you have wanted your capital for the last two years?

Buyout Success: The (Un)Expected

This chart shows the gross returns for buyout private equity funds by sector. As you can see, gross returns by sector are neatly grouped in a mid-teen to mid-twenty percent range. You might think that IT and Healthcare would be among the best performing sectors due to their faster growing top lines. And you’d be correct: out of the top three performing sectors, they represent first and third place respectively.

What you might find surprising is the materials sector came in second, illustrating that buyout success is also a function of operational improvements and purchase price, rather than having the wind at your back.

Rock Steady: Buyout Gross Returns

Our chart this weeks dives down into the actual deal level returns of every buyout private company that we have in our database, and yes, it is a very sizable and statistical sample. As you can see, the gross returns over time have continued to average around the 20% level. Higher levels occur after times of broken equity markets and risk avoidance (think post-2000 and post-2008). Returns are often better when fewer investors are around. It makes you wonder what the post-2022 private equity buyout returns will look like.

Bullish Days Ahead?

The rate of flows into and out of the private markets fell significantly from the torrid pace in 2021. New deal activity fell sharply as  inflation, rising interest rates and economic uncertainty forced buyers to put their pencils down until the outlook for risk assets became clearer. Also, a reduction in distributions from a slowdown in IPOs and acquired companies left the institutions with less capital to commit to new private market funds. 

Both conditions have started to shift in 2023, as the bounce in public markets is beginning to draw buyers off the sidelines. Likewise, the upswing in public equity values appears to be leading to an opening of the IPO and M&A windows as investor appetites recover. 

The View of the Forest

During periods of downturn and uncertainty, it’s easy to focus on short-term performance. So, fire up the drone and let’s get a good look at the forest. Here we have a chart of 10-year rolling returns, which demonstrates that while there are brief moments in time when public equities do outperform historically private equity investing wins most of the time. 

It’s important to note that this performance is the average of all private equity. Imagine if you were skilled at investing in only the top half or even top quartile of private market funds or assets....

Is Now the Time?

Many investment firms missed the last big move in the market as their investment models went defensive when the Federal Reserve raised rates to fight inflation. It now appears that a rapid slowdown in job creation and GDP may not have been needed as inflation has slowed faster than expected. If the economy re-accelerates as inflation moderates and interest rates stabilize, defensive portfolio positioning could underperform the market as investors miss economically sensitive opportunities. But with the S&P 500 up 25% off its October lows, what is an investor to do?

For investors who believe that future public equity returns may moderate, now may be the time to look at investing into private equities. This chart shows that  when the public markets return less than a high-teens positive return over a 3-year annualized return, the private markets outperform the public markets by 400-800 basis points. Historically, private equities beat public equities when the bull is charging, but on a relative basis, not as much. So, for investors who believe that the public markets may moderate from here, we believe private equities could be just the new investment they are looking for.