Industry Trends
Private markets investment outlook July 2024: An attractive investment environment
The current state and outlook of private market investments as of Q3 2024 highlights critical points:
1. Normalization and Opportunities: Fundraising, investment activity, and valuations in private markets have returned mainly to pre-pandemic levels, creating a favorable environment for new investments. Small and mid-sized private market strategies are particularly attractive due to a concentration of fundraising in large funds in 2023.
2. AI and Long-term Trends: The AI revolution and trends like decarbonization, deglobalization, and demographics (3D Reset) drive investment activity, especially in venture and growth capital, data centers, and renewable energy.
3. Income and Private Debt: Income investments, particularly in private debt and credit, are appealing due to market inefficiencies and higher interest rates. Defensive, opportunistic, uncorrelated, and diversifying income strategies are favored.
4. Private Equity: A selective approach is recommended, focusing on sectors like AI, disruptive energy technology, and biotechnology. Early-stage ventures benefit from conservative entry valuations. North America, Western Europe, China, and India are highlighted as attractive regions.
5. Infrastructure: The energy transition segment is compelling due to its inflation correlation and secure income traits. Renewable energy technologies are crucial for decarbonization, and the current market environment favors core/core+ strategies.
6. Real Estate: Opportunities are emerging due to constraints in debt capital markets and tight supply conditions. The focus is on operational properties with strong demand-side tailwinds and inflation-linked income potential.
7. Geopolitical Risks and Diversification: Despite positive outlooks, ongoing geopolitical risks and domestic political tensions necessitate high selectivity and robust diversification within private market allocations.
Source: Schroders
U.S. private equity market recap - July 2024
The in-depth analysis of the U.S. private equity (PE) market focuses on various aspects such as deal activity, valuations, fundraising, exits, and leveraged loans. Key takeaways from June 2024 include:
1. Deal Activity: The first half of 2024 saw a 13% decrease in deal count compared to H1 2023 but a 6% increase compared to the same period last year. Q2 2024 deal activity dropped by 22% QoQ and 19% YoY, with June experiencing the lowest monthly deal activity since mid-2020.
2. Valuations: The average LBO purchase price multiple increased to 11.1x in H1 2024 but remains below historical averages.
3. Dealmaking Outlook: Deal pipelines are refilling, and dealmakers expect a rebound in activity in the second half of the year.
4. Top Deals: Bain Capital's $5.6 billion acquisition of PowerSchool was the largest deal in June 2024. There have been 53 deals of $1 billion+ and 11 deals of $5 billion+ YTD.
5. Dry Powder & Fundraising: Dry powder remains over $1.1 trillion despite a slight decrease. Fundraising saw a slight uptick in Q2 2024 but remains below 2023 levels. LPs are focusing on large, established managers.
6. Deal Multiples & Exit Activity: LBO purchase price multiples ticked to 11.1x. Exit activity showed signs of recovery in H1 2024, but firms face pressure to return investor capital.
7. Leveraged Loan Issuance: In Q2 2024, $404 billion in leveraged loans were issued, up 83% year over year. Institutional volume increased by 316% year over year.
8. Outlook: Deal activity is expected to rebound in the second half of 2024, supported by stable macroeconomic conditions, high levels of dry powder, and an expected rate cut. The current environment favors secondary investors, and firms use creative methods to return capital to investors.
Source: Ropes & Gray
Market Sentiments
Global private credit: A growing investment opportunity
This piece examines the private debt market's rapid growth and evolving nature as of July 18, 2024. Private debt, which involves lending outside traditional bank loans and public debt markets, has become a significant asset class, surpassing US$1.4 trillion globally. This growth is driven by banks retreating from specific lending sectors, structural changes in public markets, and borrowers' preference for customized funding solutions. It compares direct lending, broad syndicated loans, and high-yield bonds, highlighting their respective characteristics and risks. Private debt offers high yields and diversification benefits. Still, it comes with complexities and risks, such as increased financial risk from Payment in Kind (PIK) provisions and the impact of management and incentive fees on returns. It emphasizes the importance of careful strategy selection and thorough analysis of fund managers. It also notes recent market challenges, such as the financial distress of Pluralsight, which underscores the risks of excessive leverage and inadequate protections. Despite these challenges, the private debt market presents significant opportunities for informed investors, with high returns and portfolio diversification potential. Understanding market dynamics and engaging with experienced fund managers can help mitigate risks in this growing asset class.
Source: Pitcher Partners
Private credit outlook: The heat is on
Despite narrowing spreads, private corporate loans are expected to maintain higher base rates and illiquidity premiums, making private credit appealing both absolutely and relative to private equity. Investors are advised to focus on the core middle market, where covenant protections are strong, and to seek experienced lenders with robust due diligence processes. It also highlights the need to diversify beyond corporate lending into asset-based finance, which includes consumer, residential, and commercial credit. This sector remains underrepresented in portfolios but offers diversification benefits. The importance of sound underwriting and strong relationships with originators is emphasized.
Additionally, the role of private capital in financing renewable energy and clean technology is growing, especially as banks retreat from such projects. Opportunities are noted in large solar-power markets, particularly in Europe. High rates and inflation pose challenges in commercial real estate, but selective opportunities may arise as transaction volumes recover and rates moderate. Overall, it argues for the continued growth of private credit, citing its potential to help investors navigate a changing global macro environment characterized by higher inflation and lower real growth. The illiquidity premium and inflation hedge provided by many private credit structures are seen as valuable in the years ahead. Private credit's role in financing the modern economy will likely expand, offering diversification and exposure to the real economy for investors.
Source: AllianceBernstein
Private equity adapts to the new normal in geopolitics and trade
The authors emphasize the shifting landscape of global trade and investment, highlighting the increasing influence of geopolitical risks on business. The era of deepening globalization is being replaced by rising trade protectionism, industrial policies, and expanded regulations, particularly in response to climate change and digital economy control. These changes are disrupting supply chains and leading to a more multipolar world. With their global portfolios, private equity (PE) firms are significantly impacted by these geopolitical and trade dynamics, especially in three main areas: cross-border value chains, strategic sectors, and climate regulation and policies.
PE firms need to enhance their geopolitical decision-making to mitigate risks and seize opportunities. Key sectors affected include industrial goods, tech, and energy, each facing unique challenges due to geopolitical and trade shifts. Four potential scenarios for the geopolitical landscape by the 2030s are outlined, ranging from renewed cooperation to increased global discord. Boston Consulting Group (BCG) advises PE firms to strengthen their geopolitical strategies to navigate this evolving environment better and maintain competitiveness. BCG, a pioneer in business strategy, collaborates with clients to address significant challenges and drive positive societal impact through innovative solutions.
Source: BCG
The regulatory climate is getting hotter for private equity
There is increasing regulatory scrutiny and compliance challenges faced by private equity (PE) firms in the United States and the European Union. The need for PE leaders to proactively manage regulatory risks across their firms, investment portfolios, and portfolio companies is growing. The article highlights new issues like global technology and defense competition, net zero carbon goals, ESG reporting, and cybersecurity risks. PE firms must address a complex regulatory environment that spans multiple regions and topics. They must implement comprehensive internal controls, ethics codes, anti-money laundering practices, and climate-related disclosures. In the EU, regulations like AIFMD, MiFID II, GDPR, and others address risk management, data protection, financial crime assessments, and sustainability reporting. It suggests a three-part approach for managing compliance risks:
• Conducting an overall assessment
• Adopting a compliance operating model
• Setting compliance standards across the investment portfolio
The authors stress the importance of thorough M&A due diligence to identify compliance weaknesses and the need for compliance transformation programs in portfolio companies to mitigate future risks. In conclusion, they highlight the importance of fortifying compliance frameworks to avoid the costs of addressing problems too late and mention Boston Consulting Group's role in helping businesses tackle these challenges.
Source: BCG
Mid-year Review
2024 Mid-year investment outlook: Waves of transformation
This analysis discusses a new wave of investment into the real economy, driven by five mega forces, mainly focusing on AI, the low-carbon transition, and the rewiring of supply chains. This transformation will significantly impact economies and markets, leading to higher inflation, interest rates, and weaker growth than pre-pandemic levels. Three main investment themes are outlined:
1. Getting Real: Emphasizing infrastructure, energy systems, and technology opportunities.
2. Leaning into Risk: Encouraging a deliberate blend of returns across public and private markets.
3. Spotting the Next Wave: Being dynamic and ready to adjust asset allocations based on varying outcomes.
The piece presents five near-term scenarios for the next six to twelve months, ranging from subdued growth with stubborn inflation to broad productivity gains driven by AI. Critical market views include an overweight position on U.S. stocks due to the AI theme, a neutral stance on Chinese equities and government bonds, and a mixed outlook on European equities. It stresses the importance of adapting to the evolving market environment and the potential for generating above-benchmark returns. U.S. stocks: To stay overweight U.S. stocks and the AI theme on a six- to 12-month view. Japanese stocks: The overweight to Japanese stocks is one of our highest-conviction views on an improving outlook of higher inflation, wage growth, and corporate pricing power. Private markets: To see private markets as an avenue to tap into the early winners and the infrastructure needed for the investment boom ahead. The real economy will be a focal point, with infrastructure, energy systems, and technology investments playing a critical role in shaping the future. Still, private markets are complex and only suitable for some investors.
Source: BlackRock
Searching for momentum: Private equity mid-year report 2024
The current state of the private equity market highlights several key challenges and strategies for improvement. Despite some large headline deals, overall market activity remains low, and exits have significantly slowed down, impacting funds' ability to raise new capital and satisfy limited partners (LPs). The macroeconomic environment, characterized by high inflation, geopolitical uncertainties, and an inverted yield curve, further complicates dealmaking. General partners (GPs) are struggling with low distributed to paid-in capital (DPI) levels, and many expect a slight improvement in the deal market before 2025. The number of active portfolio companies has doubled over the past decade, stretching management resources thin. Rising interest rates and inflation have increased the stakes of holding assets longer, making it harder to gauge portfolio strain. Fundraising has become polarized, with the largest and most experienced funds attracting the most capital. GPs employ creative strategies like coinvestments and continuation funds to buy time, but the outlook remains challenging. To succeed, funds need to change their narrative and focus on understanding LPs' true perceptions and expectations.
Four broad areas of focus for funds are outlined:
1. Conducting a clear-eyed assessment of market perception.
2. Developing a comprehensive, portfolio-wide plan to meet LP expectations.
3. Reevaluating the firm's value-creation model.
4. Rebooting investor relations to build a robust commercial organization.
The priority is demonstrating disciplined, unemotional plans for generating returns and distributing capital on time to reassure LPs.
Source: Bain & Company
Artificial Intelligence Scope/ Trends
Data-driven strategies: The winning edge in private equity
Private equity firms face challenges due to macroeconomic headwinds, high financing costs, uncertain growth outlooks, and increased competition. Firms are turning to data and AI-driven strategies to innovate and differentiate themselves. However, many firms need help with reliable data collection and integration due to limited infrastructure, data management process challenges, and lack of data governance. Manual data collection is not scalable, and executive accountability for data and analytics is often lacking. Underinvestment in data, AI, analytics infrastructure, and data quality tooling and operating models further impedes effective data usage. Leading firms are beginning to collect diverse data types, such as financial, customer, supplier, workforce, and ESG data, to enhance reporting and use cases. Modern data, analytics, and AI capabilities can unlock value throughout the deal lifecycle, aiding fundraising, deal sourcing, due diligence, investment growth, and portfolio monitoring. By aggregating high-quality data, firms can better identify opportunities and provide strategic actions to support their investments. Deloitte United States offers trends, insights, and tips for private equity firms to embark on a data-driven journey and create additional value across the investment lifecycle.
Source: Deloitte
A clear-eyed view of gen AI for the private equity industry
Generative AI (gen AI) can significantly enhance the operations of private equity (PE) firms. Brian Vickery and Ben Ellencweig explore various applications of gen AI, including code generation, content creation, human engagement, and virtual knowledge work. Despite the hype, only a small percentage of companies have adopted gen AI at scale, highlighting the need for effective change management and data governance. PE firms want to leverage gen AI to create efficiencies and compare innovations across industries. The approach involves:
• Starting with small use cases and strategic workflows.
• Measuring progress.
• Understanding the problem to see if improvements impact the bottom line.
Though not substantial, funding for gen AI projects can yield significant returns and faster ROI compared to previous IT projects. It also addresses the differing perspectives on gen AI among portfolio operations partners, CEOs, and deal teams, emphasizing aligning these groups. It suggests a three-pronged approach: organizing data and governance, educating colleagues, and developing a road map for portfolio-level applications. The challenges include:
• Managing messy data sets.
• Setting up centers of excellence.
• Addressing the psychological aspects of change management.
Finally, the article touches on the environmental impact of Gen AI, such as the carbon footprint of data centers and the demand for electricity and AI chips. An analogy is used to compare Gen AI to an intern—structured and organized but potentially flawed yet capable of advancing thinking in many cases.
Source: McKinsey & Company
