The remarkable post-Covid rally in global private equity met its match with the Fed's mid-2022 interest rate hikes. Despite considerable headwinds, the industry maintained a robust performance till then, marked by a historic deal activity streak. The sudden policy shift led to a significant dip in deal-making, exits, and fundraising, ending a 12-year up cycle. The looming question for 2023: will the tightened monetary policy usher in the much-anticipated recession, or can the economy hold steady amidst rising rates and uncertain macro forces? The landscape is precarious, with the industry grappling with diminished access to affordable debt financing.
Figure 1: Investments, exits, and fund-raising all declined in 2022 as macro forces took their toll
Figure 2: Dealmaking and exits slowed through the second half of the year, while fund-raising remained below 2021’s peak
Figure 3: The current macro environment poses a range of significant challenges
The global economy faces unprecedented uncertainty through at least the first half of 2023, differing from past crises due to unclear indicators and unique challenges such as a war in Europe and significant inflation. This uncertainty is hindering large private equity deals as all parties await economic clarity. Despite these challenges, smaller transactions continue through private credit and larger equity contributions, though a decrease in new deals and exits is expected to affect fund-raising adversely. Limited partners will likely experience portfolio imbalances and reduced cash flow from past commitments, leading to a short-term cash squeeze.
Figure 4: With inflation hitting its highest levels in 40 years, most private equity fund managers are in uncharted territory
Record-breaking allocations to private equity in recent years have left limited partners reluctant to make new commitments, affecting midsize funds the most. Despite challenges, including a stagnant market for initial public offerings, the long-term outlook for private capital remains strong, with private markets offering better returns and more diversification options compared to the public markets, which are currently dominated by a few large tech firms. The continued growth of private markets is expected due to these advantages.
GPs are fostering growth by creating new fund structures across different asset classes, catering to LPs' specific needs and targeting untapped capital sources such as sovereign wealth funds. The industry, holding a record $3.7 trillion in unused funds as of the end of 2022, is on standby for clearer economic indicators to resume dealmaking confidently. The approach to navigating the present uncertainty is through calm assessment and strategic planning, as learned from past downturn experiences.
Mitigating risk: Confidence boils down to learning how to underwrite risk in a time of great macro uncertainty. This confidence flows from a different set of muscles than most GPs are used to exercising.
Figure 5: Buyout continues to expand, but most other alternative asset classes have been growing faster over the last decade
Deal teams focusing on macro factors are better equipped to navigate current market uncertainties. Identifying and planning for the 2 or 3 critical factors affecting a potential deal can help secure profitable opportunities even in a downturn. Successful teams remain aggressive and open to compromising on debt and equity conditions to seize valuable opportunities, planning to adjust as market conditions improve.
Figure 6: Investments made coming out of a downturn typically generate superior returns over time
To succeed in a downturn, companies should avoid overreacting by excessively cutting costs, which can harm long-term performance. Instead, they should adopt a balanced approach, conserving resources while also seeking opportunities to outperform competitors and increase market share. Being strategically aggressive rather than overly conservative can yield better results over time.
Investments
While alternative investments overall trended downward in 2022, the buyout and growth categories took the brunt of the macro headwinds.
Buyout blues
In 2022, the global buyout value decreased by 35% compared to 2021, amounting to $654 billion, with the total deal count dropping by 10%. Despite the decline, it was the second-highest performance historically, mainly fueled by a strong start in the early months of 2022. The latter part of the year saw a significant reduction in activity, partly due to central banks' efforts to curb inflation and market disruptions in the Asia-Pacific region owing to COVID-19 restrictions. The technology sector maintained nearly a 30% share of all global buyout deals.
Figure 7: Global buyout value dropped by more than a third in 2022 as banks veered away from large transactions over the summer
Figure 8: Buyouts continued to soar globally in early 2022, but momentum slowed substantially across regions in the second half
Figure 9: Growth was down or muted across all sectors, although technology still accounted for almost 30% of all buyout deals globally
In 2022, the banking industry's reduced willingness to finance large leveraged transactions led to a 50% drop in leveraged loans in the US and Europe, declining to $203 billion. This resulted in smaller average deal sizes, which fell 23% to $964 million, and an increased prevalence of smaller transactions, often facilitated by direct lenders. Add-ons represented a significant portion of the transactions, accounting for 72% of all North American buyouts, as they were utilized to expand businesses and enhance valuation through buy-and-build strategies.
Figure 10: As monetary policy tightened globally in 2022, banks pulled the plug on loans for large leveraged buyouts
Figure 11: Although average deal size remained high, the financing squeeze meant smaller deals gained share
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