“Signs of resilience and reduced uncertainty.”
We suspect that is not quite how you expected us to describe the European investing environment in late 2022, but the economy has managed the shocks unleashed by both the pandemic and Russia’s aggression against Ukraine remarkably well. The last nine months have been buoyed as a result of what did not happen, as opposed to what did. In May 2023, the European Commission even nudged up the growth forecast across its member countries as lower energy prices, abating supply constraints and a strong labour market supported moderate growth in early 2023.
It is worth reflecting on the data as we consider this favourable picture in the European private markets. Europe has done more than “Keep calm and carry on” in the face of many headwinds such as inflation, rate rises, war on European soil and the aftermath of Brexit. In fact, it has continued to earn and deserve its position as a core exposure within a thoughtful global private market portfolio.
Quarterly performance in European private equity funds fell from grace in 2022, but just like their global counterparts, they still bested publicly traded peers over the course of the year. This is unsurprising given the history of outperformance in private markets and its tendency to outperform to a greater extent during public market downturns. However, it remains an important reminder as to why we believe private markets are here to stay (and to grow!).
2022 Quarterly Returns
Western European private markets, on average, showed a narrower dispersion of returns than the global equivalent measure of all private markets over the past 15-year cycle.
Western Europe Private Markets Dispersion of Returns
Interquartile Range by Vintage Year
The region has remained healthy as we look at contribution activity, which fell after a record year in 2021. Absolute levels remain higher than pre-2021 activity and neared historical averages as a percentage of global contributions, indicating a healthy deal environment.
Annual Western Europe Focused Private Market Contributions
RATE OF CONTRIBUTION
Annual Western Europe Contributions as a % of Unfunded
Distribution activity presents a similar picture despite more challenging exit conditions, with 2022 distributions nearing historic highs from 2021, and European rates of distribution surpassing global peers last year. We’ve been hearing the phrase “DPI is the new IRR,” and we’d beg to differ. For us, IRR remains a key performance metric and we aren’t seeing much issue with DPI generation through to mid 2022, especially as debt and equity capital markets continue to tease the market with partial short openings and cautious optimism. But distribution rates have slowed in H2 2022 and 2023 look to be slower, and remember that not all DPI is created equal as we will further talk about later with the growing use of NAV facilities.
Annual Western Europe Focused Private Market Distributions
RATE OF DISTRIBUTION
Annual Western Europe Distributions as a % of NAV
PME relative performance in Europe is outpacing the equivalent spreads seen in North America, a consistent feature of the past 15 years, driven largely by lower PME performance in Western Europe, but also by fewer very highly priced and highly levered deals relative to North America.
Private Equity IRR vs. PME Spread
By Vintage Year
Purchase Price Multiples Distribution
Deal Years 2018-2022
Leverage Multiples Distribution
Deal Years 2018-2022
Let’s not forget European private equity is a collection of national markets, and manager selection is critical. Whilst the deal return data suggests there are attractive opportunities throughout the continent, economic benefit and beta generation will be unequal. This is a time to partner with those generating alpha on a stable and repeatable basis.
Gross Buyout Deal IRR Quartiles
By Country, Deal Years 2001-2018
It’s not all headwinds on the investment side, though. Europe is leading on the sustainability and climate investing front, with green transition set to transform global industry and with a fierce head start, Europe remains in a good position to capture contributions flowing into sustainable products. A consistent featured theme from the recent Annual Meeting season, AI is also top of mind for European GPs, and we expect to hear and see more from this part of the ecosystem as AI applications emerge. The winners here are yet to be seen as we look to see which GPs successfully incorporate AI tools as a new feature in their operating toolkit as an enabler of value creation.
Despite the unique thematic opportunity set within the European landscape, fundraising has declined sharply, veiling the industry in negative sentiment. Diving into the breakdown of fundraising, we can understand the frustration of European GPs. Fundraising peaked for Western European funds between 2018 and 2019, perfectly positioning subsequent fund launches in 2022 and 2023. It was the perfect storm: funds deployed across the peak of the market, delays in launches due to the prioritization of global funds in H1 2022, and further delays due to LP liquidity and underwriting challenges.
Private Markets Fundraising
Western Europe Private Markets Fundraising
Investors will have recognized that some European GPs do themselves no favors on the fundraising cycle right now, falling back on traditional European conservatism, such as marketing a target mid-teens net IRR for an equity strategy, despite underwriting and projecting to higher outcomes, and proudly holding asset value ‘conservatively’ for longer despite positive trading with the biggest jump in value at exit. This “we expect it will be better” approach can be easily misunderstood by the non-European investor as low conviction.
The re-emergence of a European allergy to the word “change” post-pandemic, has, in some cases, hindered the transparency of critical LP communications around current headwinds like debt serviceability, cash cover and cost pass-through; data here remains highly inconsistent today and top of mind for LPs in a higher rate environment. European GPs, those who come ready to address topical and current headwinds to LP meetings, rather than waiting for LPs to ask the questions before you look at the data, are received much more positively by the LP.
Contrast this lack of proactive communication with Europe vocally leading the global charge on the use of fund level leverage via NAV facilities – some of which are accretive to portfolios, whilst others provide LPs the unfortunate privilege of driving recallable DPI at floating rate cost, which are now often above the preferred return.
The growth and maturation of European private equity will be predicated on the ability of Europe to attract non-European LP capital in the next cycle. Some GPs seem to agree with us and are acting accordingly.
Keep Calm And…
What action should an LP take when faced with this picture? Given the positive market data, in our view Europe should remain a core exposure within a global private market portfolio. Europe is capitalizing on a challenging market to drive alpha and opportunities in key themes such as sustainability and AI. However, it remains a complex collection of local markets, each with its own attributes and risks to navigate, as well as a set of culturally driven behaviors which may seem curious and detrimental to the non-European. Be cautious when determining with whom to partner, but don’t shy away from this market, which we expect will continue to drive attractive returns.
EUR/USD Fx Rate: The exchange rate between EUR and USD currencies
MSCI Europe: The MSCI Europe Index tracks large and mid-cap equity performance across 15 developed market counties in Europe.
All PM / All Private Markets: Includes all private commingled funds excluding fund-of-funds, secondary fund-of-funds and co-investment funds.
Western Europe PM: Includes all private markets funds that primarily invest in the European Union
Western Europe Spread: The difference between Western Europe Private Equity and their relevant Public Market Equivalent performance. The PME here is using the MSCI Europe for the PME calculations.
North America Spread: The difference between North America Private Equity and their relevant Public Market Equivalent performance. The PME here is using the S&P 500 for the ME calculations.
Western Europe: Any portfolio company that primarily invests in the European Union
North America: Any portfolio company that primarily invests in North America.
Western Europe Contributions: Western Europe PM contributions
Western Europe Distributions: Western Europe PM distributions
Western Europe Contributions as % of All PM Contributions: Western Europe PM contributions as a percentage of All Private Markets contributions
Western Europe Distributions as % of All PM Distributions: Western Europe PM distributions as a percentage of All Private Markets distributions
There are a number of factors that can affect the private markets which can have a substantial impact on the results included in this analysis. There is no guarantee that this analysis will accurately reflect actual results which may differ materially. These valuations do not necessarily reflect current values in light of market disruptions and volatility experienced in the fourth quarter of 2020, particularly in relation to the evolving impact of COVID-19, which is affecting markets globally.
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As of July 27, 2023