What is the private equity asset class?
Private equity involves investments in companies that are not listed on public stock exchanges. There are three broad categories of private equity, focused on different stages of a company's life: venture capital, growth equity and buyouts.
Companies are increasingly choosing to stay private for longer than they used to. Consequently, public equity now represents only 15% of the total public equity universe, with private equity comprising the remaining 85%.1 By investing in private companies, particularly at earlier stages, private equity firms can capture the growth and value creation of these business in a way that is not available through public markets.
What’s happening now?
After reaching record transaction volumes between 2000 and the first half of 2022, last year saw a notable slowdown in US private equity deal activity. Declines began to unfold in the second half of 2022 and continued through 2023 due largely to two major market shifts.
First, the runup in interest rates made debt more difficult and expensive to access. This had a more material effect at the large end of the buyout market, where most deals are executed using leverage. Second, investors became overallocated to private markets as the value of their public portfolios declined due to the broad declines posted by traditional public equity and fixed income markets across much of 2022.
This dynamic continued to dampen fundraising in 2023. Muted deal activity may continue into 2024 given that the interest rate environment remains uncertain. However, at the same time, these dynamics have created a number of attractive entry points.
Robust private equity manager and asset due diligence will be crucial to success in the year ahead. The dispersion of manager returns in the asset class has always been relatively large across vintages over the years, especially in the small mid-market, and this dispersion may increase further given continued uncertainty in the market.
Despite recent volatility, we believe private equity continues to be a solid investment opportunity. While past performance cannot reliably predict the future, historically the asset class has often been an outperforming investment following periods of dislocation. Earnings growth remains solid, while continued technological advancements are driving innovation and efficiencies across industries, as well as pricing dislocations, which have created attractive opportunities. Choosing the right partner will be critical to navigating the complexities and breadth of this compelling opportunity set.
Where are we seeing opportunities?
In this environment, we are seeing opportunities in several areas:
Emerging opportunities in secondaries and co-investments: The current market environment has fuelled significant interest in secondary transactions and co-investments. The overall market continues to see secondary interests priced at a discount to net asset values (NAVs), providing a favourable entry point for secondary buyers.
Given the significant slowdown in distributions across the market, selling private equity interests on the secondary market has created liquidity for limited partners (LPs). While discounts offer an added layer of immediate upside, secondary returns are primarily driven by asset appreciation. Thus, it remains critical to evaluate the underlying asset quality.
Co-investments – investments made directly into a single company alongside a general partner (GP) – are also an attractive part of the market. These investments can generally be an opportunity for GPs and LPs alike. Amid fundraising challenges, GPs can offer co-investments to strategic partners to reduce their overall capital commitment, and staples are a way to entice LPs to future primary commitments. With co-investor capital, GPs can upsize their equity checks, and LPs can gain access to a potentially high-returning, targeted opportunity alongside a strategic partner.
Continued focus on small mid-market: On the buyout side, our view is that the small mid-market remains more attractive than the large and mega-markets given the segment’s structural characteristics. Entry multiples tend to be more favourable, due to the fact that the small mid-market is relatively less competitive for investors and offers more room to find pricing dislocations.
The small mid-market segment could offer higher return potential, with top-quartile performance data showing that smaller fund sizes outperformed larger funds by more than 200 basis points over 2010 to 2020 vintages.2 Businesses in this segment are often still family- or founder-owned at the time of investment and can benefit greatly from enhancements in the form of organic and inorganic expansion and operational improvements.
The segment is also less sensitive to current IPO headwinds, which have weighed heavily on the exit possibilities of large private equity deals. Instead, the small mid-market has a broad range of exit avenues. In addition to IPO, small midmarket companies often also exit via strategic acquisition or acquisition by another financial sponsor.
Why J.P. Morgan Asset Management for private equity?
- EUR 20 billion in assets under management
- 40+ years of private equity investing
- 24+ years average senior portfolio manager tenure
- 1,300+ private equity investments since 1980