Can Stronger Fiscal Activism Boost Private Equity in Europe?
According to the 2025 edition of the Long-Term Capital Market Assumptions released by JPMorgan last October, the next 10 to 15 years will be characterized by:
Private Equity Has Delivered Strong Returns Even During Periods of High Interest Rates…
In such a constellation, JPMorgan’s forecasters project long-term annual returns of Private Equity (PE) and Venture Capital (VC) at 9.9% and 8.8%, respectively. The 2024 edition (released in Fall 2023) had estimated these returns at 9.7% for PE and 9.2% for VC (see footnote 1). These performance figures can largely be attributed to a macroeconomic environment shaped by the impact of governments increasing their deficits, which would—at least partially—offset the end of the cheap money era.
Can we reasonably bet on the positive impact of stronger fiscal activism in the Euro Area to offset lasting high interest rates? Looking at Figure 1 below, one could reasonably argue that we should not care at all. PE returns have been particularly robust during periods of both high (2005–2007) and low interest rates (2010, 2013, 2020, and 2021).
…But With Relatively Weak Growth Forecasts, Public Spending Could Provide Support…
Unfortunately, higher interest rates in the past were related to strong economic growth in real terms. Table 1 shows that the annual real GDP growth rate in Europe between 2000 and 2007 was measured at 2.2%. Adding inflation to this percentage reveals that the private equity industry benefited from a nominal growth rate of around 4.2%. JPMorgan and the IMF’s forecasts for the period 2025–2029 are quite close, with a real GDP growth rate of 1.3%, which translates to a nominal growth rate of 3.3%. This would be 20% lower than the growth rate experienced in the 2000’s.
…If Only Some Member States Were Not Constrained by Years of Overspending…
In a less benign macroeconomic environment, fiscal stimulus could then act as a booster. However, can members of the Euro Area afford it? Figure 2 shows that government deficits have already been massively used since 2009 (light green bars), in conjunction with low interest rates and extensive quantitative easing by the ECB (dark green bars, representing the expanding ECB balance sheet). In 2022 and 2023, government deficits were the only remaining supportive mechanism while interest rates shot up (yellow line) and the ECB’s balance sheet contracted (red bars).
Consequently, the debt-to-GDP ratio in the Euro Area has significantly increased from 2009 to 2020 (see figure 3). Despite a reduction initiated in 2021, this ratio remains at 88%, significantly higher than its 2000–2007 levels (around 70%). JPMorgan recognizes the potential inability to use public deficits as an expansive factor.
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…Highlighting the Need to Select GPs Based on Geographical Focus…
The remedy suggested by JPMorgan for investors in such a situation is the old “manager selection” fix. What does this mean in practice? A good starting point would be to focus on managers capable of deploying capital in Member States that can afford an expansionist fiscal policy. Figure 4 shows a highly heterogeneous situation across countries. Italy, France, and Spain lack room for manoeuvre, with government debt exceeding 100% of their annual GDP. Others, such as Germany, are more promising. Germany is an interesting case, as massive public spending is expected in both energy and defence due to external pressures.
…And Targeting Priority Sectors Identified in the Draghi Report
Another good starting point is identifying sectors that might be targets of government programs. The Draghi Report, released in September 2024, could become the roadmap for many industrial policies across the Euro Area in the coming years. While energy and defence have been on investors’ radar for some time, the Draghi Report identifies specific opportunities to consider, such as for example:
Public Spending Will Not Be the Primary PE Booster in Europe, but Expansionist Monetary Policy May Return…
Even if government spending remains relatively high in the Euro Area, there is no reason to believe that its multiplier effect will increase to the point where fiscal policy could match the supporting measures that benefited the industry before 2022. However, a positive development could be the return of expansionist monetary policy.
… In a Challenging Context That Demands Careful General Partners Selection
Does such a scenario seem unrealistic? One of the key drivers of the macroeconomic environment identified by JPMorgan is increasing nationalism, with higher tariff and non-tariff barriers to global trade. In a tit-for-tat context, potential competitive devaluations through decreasing interest rates could create both opportunities and threats for private equity managers.
Selecting the right General Partners now means identifying investment strategies that would benefit from targeted government programs, remain relatively immune to higher trade barriers, and have the potential to capitalize on future decreases in interest rates.
Footnote:
(1)?? In a post released in February 2024, I cautioned that JPMorgan's long-term forecasts (10 to 15 years) are relatively weak in providing indications of asset class performance over the next three years. I have updated the slide comparing JPMorgan’s forecasts to actual returns, first released in early 2024. Figure 5 shows that the long-term forecasts made in October 2021 for 2022 and beyond are better aligned with the preliminary actual average return from 2022 to 2024 than the previous forecasts (made in 2020 for 2021 and beyond, compared to the average return observed from 2021 to 2023 included). Whether this improved accuracy will hold in the future remains to be seen.