Global private equity activity is on a roll. In 2017 the industry announced 5,224 transactions, an annual record for volume, while the US$879 billion worth of deals marked a post-crisis high. After a banner year, the asset class has shown no signs of slowing down in 2018—US$181.24 billion changed hands in the first three months of the year, marking the highest Q1 deal value since 2007.
So why is the asset class performing so strongly?
1. Exceptional Returns
The PE industry has consistently delivered double-digit IRRs for investors and outperformed stock markets over time. In its 2018 private equity report, consultancy Bain & Company, quoting data from Cambridge Associates, found that over a five, ten and 20-year investment horizon buyout funds have secured superior returns to equities in the US, Europe and Asia. Investors have taken notice and supported private equity managers accordingly.
2. Record Dry Powder
Strong investor appetite for private equity means the asset class has more cash at its disposal than at any other time in history, and money continues to flow into new funds at a steady rate. According to data provider Preqin, 921 private equity funds held a final close in 2017, raising a record US$453 billion to push dry powder to an all-time high of US$1 trillion. With overflowing war chests available to them, private equity firms have become formidable M&A players with the financial resources to take on strategic buyers head-to-head.
3. Cheap Debt On Favorable Terms
Private equity houses have been able to source readily-available debt at attractive prices and on good terms. Debtwire reports that for 2017, “covenant-lite” loans—which place few obligations on lenders—represented 74% of institutional (term loan B) volume in the US and 76% in Europe. While the overwhelming objective of PE firms is to build value by growing each of their portfolio companies, and while the availability of leverage does increase risk, cheap debt has the potential to help investors maximize returns.
4. Performance Enhancement Through Digitization
The spread of digital technology across all industries has played to private equity’s strengths of identifying trends early and having the space to manage businesses through change, away from the glare of public markets. The influx of data analytics tools into the market has enhanced the ability of PE funds to conduct accurate due diligence and gain a better understanding of market trends within a sector. This enables these investors to enhance the profitability of a firm during its holding period.
5. The Emergence Of New Managers
The industry has not been allowed to stagnate, with new managers consistently coming to market with new strategies and fund structures that offer investors a broader selection of risk/return profiles and fee costs. These new players have come to market with innovative offerings, which have attracted investor interest. Vaultier7, for example, will invest exclusively in challenger brands in the beauty, personal care and health and wellness industries. UK-based firm Stanhope Capital, meanwhile, has raised a debut direct private equity fund where anchor investors can share in carried interest payments (the bonuses paid to the manager when a fund clears returns hurdles) and opt out of one of the deals a fund does during its life. This gives investors more flexibility and control over their capital.
These five strategies are opening up avenues for growth within the global private equity industry and will be areas to watch in 2018. - White & Case