Exit activity may increase given the performance of public equity markets but is expected to be soft compared to history.

In brief

  • Private equity valuations have been slow to adjust to the rising cost of leverage, but multiples may fall further, creating a better outlook for private equity investors.
  • Exit activity is expected to remain subdued given rates uncertainty and as companies are held private for longer to increase value creation.
  • Opportunities exist in the secondary market given pricing discounts and increased activity by limited partners to replace missed capital distributions.
  • Favoring a smaller size bias may also unlock more investment opportunities and exit strategies compared to the large and mega-cap sectors.

Outperforming in a period of dislocation

Private equity (PE) did not experience the same correction in 2021 and 2022 that public equities went through. The assumption was that the pain would come later and multiples on PE would recede.

However, looking at the history shows that the drawdown in PE compared to its public equity proxy (U.S. small cap) is typically much smaller. In 2022, PE only declined by 2% and then rebounded, driven by the resilience in both the U.S. economy and corporate profits. By the end of February, PE returns were 3.2% higher than the end of 2021, compared to U.S. small cap stocks, which were 7.0% lower.

Equity markets have repeatedly reached all-time highs this year as valuations have re-rated and earnings expectations improved. Decomposing the 10.6% total return of the S&P 500 for the first quarter of the year shows that 7.4%pts came from rising multiples. As valuations in public markets rise, and concentration concerns are yet to subside, this can create a different type of risk for investors’ portfolios. 

Investors can turn to private markets, and PE, for enhanced alpha and prospectively higher returns, while still having exposure to the secular growth themes that have driven the public equity markets higher.

Valuations slowly adjusting

While overall PE multiples may still seem high, they have declined given the impact of higher rates on the use of leverage in deals as the cost of debt financing increased. PE multiples peaked in 2022 and have since declined, and the debt component of PE multiples is the lowest since 2010. The higher overall multiple is still justified given that earnings and revenues have held up in the sectors and market size that are often the focus of PE activity, i.e. technology and mid-cap.

This has been a buyers’ market, with few sellers willing to exit in a weak climate. Given the restrained deal activity, gaining a clear insight on appropriate valuations can be difficult. The deals being completed have tended to be higher quality, with lower use of leverage, as such can attract a higher multiple.

However, deal activity is expected to increase with the better economic outlook, the rising expectation of a decline in interest rates and improved access to debt financing. This may entice sellers to return, however, it may also potentially lead to lower multiples as more lower quality deals are brought to market. 

A more attractive entry point and assumption of falling debt cost could set up 2024 vintages for strong returns. However, legacy investments may still be challenged given the softness in exit activity.

Source: Golub Capital, Greenhill, Jefferies, LCD, Pitchbook, J.P. Morgan Asset Management. *Secondary pricing of LP portfolios.
Data reflect most recently available as of February 29, 2024

Exit activity improving but remains challenged

Initial Public Offering (IPO) activity collapsed in 2022 and 2023, meanwhile mergers and acquisitions activity remains muted. So far this year, high profile IPOs have piqued investor interest, and while exit activity may improve off the lows, as there is a better balance between buyers and sellers, there is no expectation of a surge in exits.

It is also worth noting that the expectation for central bank easing is one of gradual rate cuts and a much shallower path, rather than a return to “cheap” money that may have fuelled higher levels of activity in the past.

This would be more of a headwind to mega-cap deals that make much greater use of leverage. A focus on small and middle market companies and lower leverage deals may be a more prudent strategy.

Secondary market for opportunities and liquidity

Activity in the secondary market is expected to remain robust as limited partners (LPs) are seeking liquidity to either rebalance portfolios and replace missed capital distributions.

PE investors that purchased assets in the pre-COVID years have been holding on to companies longer as they wait for a better exit environment. The average holding period of companies extended from 5.1 years in 2021 to 6.4 years in 2023, the highest since 2015. However, there is increasing pressure to return capital to investors, who would be looking to roll into new funds.

Selling PE interests in the secondary market has helped to create the liquidity and provide capital required by both general partners and LPs.

The increased activity in the secondary market has led to an improvement in pricing, but these remain favorable with overall secondary pricing trading at a 15% discount to net asset values (NAV), and deeper discounts available in venture capital and real estate.

Investment implications

The muted drawdown in PE in periods of turmoil is a function of the illiquid nature of private market investing. Often the illiquidity is viewed as an obstacle to investing but can become a benefit if it mitigates the volatility of short-term market fluctuations on a portfolio.

Exit activity may increase given the performance of public equity markets but is expected to be soft compared to history. As such, the secondary market will provide opportunity for investors given the better valuations and existing NAV discounts. The secondary market comes with the added benefit of J-curve1 mitigation.

Meanwhile, the bias towards the smaller end of the market is likely to yield a greater number of potential deals with less dependence on leverage in what could be an extended higher rate environment. Exit activity may also be higher in smaller-mid market segment given the additional exit opportunities to transact with larger PE funds rather than relying on public market listings.

As with all alternative investments, manager selection is crucial to the success in long-term investments given the wider dispersion in returns compared to the public market equity managers.  


1The J-curve represents a tendency of PE funds to record negative returns in initial years given investment costs and cash outflows but much larger ones in later years as investments mature. Acquisitions in the secondary market can diminish this J-curve effect by either reducing the period of cash outflows or returning cash to investors more quickly.