Private equity is prepared for resiliency in the face of downturns

Following a decade of unprecedented growth, private equity (PE) firms now globally manage more than US$3.8t in assets, which is more than double the amount managed at the point of the 2008 global financial crisis. However, a period of increased economic volatility driven by geopolitical instability, changing societal expectations, pockets of market excess and sector disruption has the potential to limit growth. The future outlook is one of increasing uncertainty.

Private equity is a vastly different industry than it was 10 years ago. Our latest report Why private equity can endure the next downturn unpacks some of the current and future dynamics that are influencing the private equity industry and identifies four significant changes that are likely to play an important role in determining how well PE performs in the next economic downturn. These changes are as follows:

An abundance of available capital

As long-time limited partners in PE increase their exposure to the asset class and a wide range of new entrants – including family offices, sovereign wealth funds and high net worth investors – invest in PE for the first time, PE firms have more capital at their disposal than ever before – and in fact many have been patiently waiting to invest into a market like we may be seeing. The aggregate amount of committed capital PE can readily deploy stands at more than US$2.8t.

Diversification has increased PE resilience

PE firms have heavily diversified across a wide array of private capital strategies, including growth capital, real estate, infrastructure, sector-specific funds, and in particular, private credit. As demonstrated during the last downturn, distressed lending proved particularly useful as a counter-cyclical source of capital, and together with private credit’s significant dry powder, represents an important credit buffer during times of weakness in the traditional credit markets.

Expanded operating capabilities

The imperative to reshape portfolio companies via continuously improving their operating capabilities (whether adding operating partners, improving technology or developing sector or functional expertise) has become more significant. As a result, firms are better situated to respond to the challenges of economic dislocation at their portfolio companies. Moreover, they’re well positioned to capitalize on the opportunities it might afford, such as investing in complex carve-outs, assets in need of optimization, or buy-and-build strategies to effect consolidation.

Greater sophistication among limited partners

During the last crisis many limited partners were constrained from investing additional capital in PE by the “denominator effect,” which happened when the valuations in their public portfolios fell dramatically, and many limited partners found themselves suddenly over-allocated to private investments relative to their target allocations. Today, the secondary market has become a tool that is used widely by limited partners looking for liquidity or to make adjustments to existing portfolios. The result is more flexibility for investors to adjust to volatile market conditions.

Private equity has evolved significantly over the last decade, and this evolution will continue. The PE industry is a larger, more mature and a better resourced industry with a broader set of strategies and the wherewithal to prevail in the next downturn. For PE, a downturn represents a chance not just to invest in attractive companies at compelling valuations, but for the industry to further assert itself as a foundational bedrock of the modern global economy.