Rising interest rates managed to derail the 12-year bull run for private equity investors, but managers are looking to individual investors for growth, according to a report from Bain & Co.
The Boston-based consulting firm’s 2023 global private equity report said global buyout value totalled $654 billion (all figures in U.S. dollars) in 2022, a 35% decline from 2021’s record-breaking $1-trillion total.
Deal count fell by 10% to 2,318 transactions last year. Average deal size, which had climbed every year since 2014 to a record high in 2021 of $1.2 billion, dropped by 23% in 2022 to $964 million.
Deal exits saw an even more dramatic reversal as sharp falls in public equities led the IPO market to essentially shut down, the report said. Buyout-backed exits dropped by 42% in 2022 while growth equity exits plummeted by 64%.
Still, last year’s deal value was enough for the second-best performance historically due to a strong first half.
However, macro conditions remain challenging for private equity investors, with uncertainty a “deal killer,” the report said.
“[D]eep ambiguity about the future course of global economic activity is likely to cast a shadow over the private equity value chain through 2023’s first half, if not beyond,” it said.
Higher interest rates will cut into returns that, to a large degree, had come from higher valuations. Fund managers “will not have the luxury of relying on higher multiples,” the report said, and returns will have to come through earnings growth. Inflation will make such growth more challenging.
The report pointed to green shoots, however — notably the growing role for “the vast, untapped market” of individual retail investors in private markets. Individual investors hold roughly half of all global assets under management, it said, but only 16% of assets in alternative investment funds.
The reported noted that large alternative managers are launching funds that give high-net-worth individuals access to alternatives. Wealthy clients and their advisors, meanwhile, “are increasingly drawn to alternative investments as they look for new diversification options and better returns than they can get in the traditional markets for public equity and debt.”
Investors are drawn by private equity returns (14% globally over the past 25 years vs. 7% for the MSCI World Index, the report said) but also by the difficulty of achieving diversification in public markets. Most investors suffered last year as large stock and bond indexes experienced double-digit losses.
The report also noted that the number of U.S. public companies has declined by about one-third in the past 25 years, and that large tech companies dominate major equity indexes.
However, Bain said there will be growing pains as retail investors enter private markets.
“When Blackstone met with significant redemptions in two groundbreaking retail funds last year, it highlighted the complexity of managing a large group of investors with very different liquidity expectations than the institutional investors PE firms are used to,” the report said.
“It will take time for the industry to work through new market challenges like these while simultaneously developing the muscles to compete in an unfamiliar arena. Experience so far suggests the industry has yet to really crack the code on retail.”
Which retail investors are being targeted by private equity firms? The report noted that the very wealthy are already invested while firms face more regulatory hurdles with the mass affluent.
“Consequently, the industry is focusing most of its attention on the large untapped market in the broad middle, using innovative fund structures and technology solutions designed to make the historical barriers less onerous,” it said.