These Five Factors Are Shaking up the Private Equity Industry

These Five Factors Are Shaking up the Private Equity Industry
February 15, 2023 9 mins

These Five Factors Are Shaking up the Private Equity Industry

These Five Factors Are Shaking up the Private Equity Industry

Private equity trends have shown that years of growth have slowed, and inflation and changing interest rates are affecting the market and complicating investment strategies.

Key Takeaways
  1. Though private equity remains strong, growth has slowed amid current economic conditions.
  2. Investors and managers are tracking changes in inflationary trends, interest rates and asset allocation levels as they navigate economic uncertainty.
  3. Current conditions offer investors an opportunity to evaluate fund managers.

Overview

In the years following the financial crisis of 2008, private equity trends have shown that the market has enjoyed solid performance, benefiting from the combination of a strong economy and low interest rates. Now, a variety of factors — economic uncertainty, rising interest rates and inflation among them — have cooled private equity activity.

“We've had a very solid run for years,” says Karen Rode, partner, Wealth Solutions at Aon. “Things are in a little bit of upheaval right now because people don't know where the economy is going and what regions of the world are going in which direction. I think there's a little bit of a pause right now and people are readjusting their thinking.”

That uncertainty is understandable. Aon’s 2022 Executive Risk Survey found 79 percent of global business leaders expecting a recession in the next year, with inflation and an economic crisis among the top concerns as well. But despite the current pause in private equity activity, there are opportunities to be had in investments and preparing for when the pace of market activity picks up.

In Depth

As market participants evaluate current private equity trends, they’re focused on a number of key considerations. The economy is a top concern, as are inflation and interest rates. For investors, there might be questions around portfolio allocations as the value of various investment classes has shifted. The current challenges also provide investors with an opportunity to evaluate private equity managers.

 

Despite the Economy, Private Equity Continues to Perform

Current economic conditions and recession fears may have slowed the private equity market, but they haven’t stopped it. Fundraising continues, albeit not at previous levels.

In the current economy, private equity investments have tended to fare better than public equity investments, according to Rode. “Control and governance are the two big differences between private and public holdings, and will always be the big drivers of value, whether you're in a down market or an up market,” she says. “The alignment of interest is much stronger in private equity than it is in public. The ability to move and make decisions for the long term without being second-guessed every quarter over earnings drives private equity versus publics.”

Considering Inflation

In an inflationary environment, businesses with the ability to raise prices may be able to increase profitability. Others who don’t have the same pricing power will be hurt, Rode says.

Inflation can also be a factor in valuing companies for private equity investments. “Valuing a public company or a private company is always an art rather than a science,” Rode says. Private equity funds will look to factor inflation into cash flow models for possible targets and seek to determine how inflation might affect those target companies’ revenue going forward.

“It’s absolutely going to impact valuations, because you’ve got different people trying to project the future and then discount it back,” Rode says.

Quote icon

Valuing a public company or a private company is always an art rather than a science.”

Karen Rode
Partner, Wealth Solutions at Aon
The Impact of Interest Rates

While a strong economy contributed to private equity’s solid performance for the 14 years following the 2008 financial crisis, an extremely low interest rate environment in that time supported that performance as well.

“Low interest rates significantly supported private equity because leverage was very much available,” says Rode. “It supported all kinds of deal flow, and the cost of putting leverage on a company was very low. Plus, it provided considerable financial flexibility.”

Now, the private equity market faces rising interest rates as central banks look to tamp down inflation. These new, higher, interest rates could mean that fundraising becomes more challenging as investors focus on other allocations strategies.

Dealing with a Shifting Allocation Mix

Some investors might see shifts in their asset allocation levels in the current market, Rode says, as private equity investments are often outperforming investments in publicly traded equities. In those cases, the percentage of private equity investments might now be exceeding investors’ allocation targets.

Rode notes that setting an allocation range may be more helpful than determining a fixed allocation target. This provides an investor some flexibility when allocation levels shift, rather than being forced to sell off investments.

“One of the last things you want to do is sell into a market that's down, because selling private equity funds on a secondary market is a loser's game,” says Rode. “If there’s a buyer for it, it’s because there’s value you're giving up.”

Investors who are concerned about private equity allocation levels may not want to exit private equity altogether. “History has shown that recessionary-type environments are some of the best performing years, so it's really not the time to back out,” Rode says. “The best route is to be able to scale back.”

A Chance to Evaluate Managers

While current conditions might be challenging for the private equity market, they provide a valuable opportunity for investors to evaluate fund managers.

“When the market’s strong and everybody’s doing really well, it’s hard to determine who the better managers are,” Rode says. “It’s when there are hiccups along the way that it becomes apparent who the really good managers are versus those just benefiting from strong markets.”

The current market might also offer investors a chance to gain access to strong managers who were previously fully committed and unavailable. “It’s a good opportunity to build out a portfolio of solid managers,” Rode says.

Private Equity’s Value Persists

Despite challenging conditions, the private equity market has a history of bouncing back, Rode says. Meanwhile, deals will continue, likely at a slower pace. “I think in another six months, deal flow will start to pick back up again, but we are going to be at a pause for a little bit,” she says. “Private equity firms will continue to find good deals, and I think there are still a lot of good deals out there.” 

General Disclaimer

The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Terms of Use

The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.

Aon's Better Being Podcast

Our Better Being podcast series, hosted by Aon Chief Wellbeing Officer Rachel Fellowes, explores wellbeing strategies and resilience. This season we cover human sustainability, kindness in the workplace, how to measure wellbeing, managing grief and more.

Cyber Labs

Stay in the loop on today's most pressing cyber security matters.

Cyber Resilience

Our Cyber Resilience collection gives you access to Aon’s latest insights on the evolving landscape of cyber threats and risk mitigation measures. Reach out to our experts to discuss how to make the right decisions to strengthen your organization’s cyber resilience.

Employee Wellbeing

Our Employee Wellbeing collection gives you access to the latest insights from Aon's human capital team. You can also reach out to the team at any time for assistance with your employee wellbeing needs.

Environmental, Social and Governance Insights

Explore Aon's latest environmental social and governance (ESG) insights.

Q4 2023 Global Insurance Market Insights

Our Global Insurance Market Insights highlight insurance market trends across pricing, capacity, underwriting, limits, deductibles and coverages.

Regional Results

How do the top risks on business leaders’ minds differ by region and how can these risks be mitigated? Explore the regional results to learn more.

Human Capital Analytics

Our Human Capital Analytics collection gives you access to the latest insights from Aon's human capital team. Contact us to learn how Aon’s analytics capabilities helps organizations make better workforce decisions.

Insights for HR

Explore our hand-picked insights for human resources professionals.

Workforce

Our Workforce Collection provides access to the latest insights from Aon’s Human Capital team on topics ranging from health and benefits, retirement and talent practices. You can reach out to our team at any time to learn how we can help address emerging workforce challenges.

Mergers and Acquisitions

Our Mergers and Acquisitions (M&A) collection gives you access to the latest insights from Aon's thought leaders to help dealmakers make better decisions. Explore our latest insights and reach out to the team at any time for assistance with transaction challenges and opportunities.

Navigating Volatility

How do businesses navigate their way through new forms of volatility and make decisions that protect and grow their organizations?

Parametric Insurance

Our Parametric Insurance Collection provides ways your organization can benefit from this simple, straightforward and fast-paying risk transfer solution. Reach out to learn how we can help you make better decisions to manage your catastrophe exposures and near-term volatility.

Property Risk Management

Our Property Risk Management collection gives you access to the latest insights from Aon's thought leaders to help organizations make better decisions. Explore our latest insights to learn how your organization can benefit from property risk management.

Technology

Our Technology Collection provides access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities of technology. Reach out to the team to learn how we can help you use technology to make better decisions for the future.

Top 10 Global Risks

Trade, technology, weather and workforce stability are the central forces in today’s risk landscape.

Trade

Our Trade Collection gives you access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities for international business. Reach out to our team to understand how to make better decisions around macro trends and why they matter to businesses.

Weather

With a changing climate, organizations in all sectors will need to protect their people and physical assets, reduce their carbon footprint, and invest in new solutions to thrive. Our Weather Collection provides you with critical insights to be prepared.

Workforce Resilience

Our Workforce Resilience collection gives you access to the latest insights from Aon's Human Capital team. You can reach out to the team at any time for questions about how we can assess gaps and help build a more resilience workforce.

More Like This

View All
View All
Subscribe CTA Banner