A year of economic uncertainty — and what private fund managers are doing about it

July 21, 2022

Private equity is facing more economic complexities in 2022 than in recent years, from inflation to widespread layoffs and the Russian invasion of Ukraine. Yet PE deals are moving forward. In light of these mixed signals from the market, asset managers will likely adjust their investment strategies.

Let’s take a look at how PE dealmaking has progressed in the first half of 2022, and how current economic concerns might impact the rest of the year.

PE dealmaking in H1 2022

Private equity deals are off to a slow start in 2022. Deal volume fell by 26% in the first half of the year compared to the same time in 2021, according to PWC. It’s important to note that many firms rushed to finalize deals before the end of 2021 due to concerns over new U.S. tax regulations going into effect this year, which likely contributed to the H1 slowdown. However, despite the ongoing economic uncertainty, Pitchbook believes dealmaking in the private markets will remain strong from a historical perspective.

Dry powder & outperformance fuel dealmaking

A reason to continue pursuing PE deals in a tumultuous environment is that global private equity dry powder reached $1.78 trillion in February 2022. Managers are sitting on a significant amount of cash, and limited partners expect managers to deploy their capital in a reasonable time.

Another motivating factor is the knowledge that capital deployed in PE deals during a downturn often performs better than during other economic environments. Historical data shows PE outperformed other major asset classes during periods of economic distress. PE has also demonstrated a lower risk of catastrophic loss compared to publicly listed equities.

Inflation & interest rates impact valuations

Much of the world is bracing for a recession. Inflation in the U.S. reached a 40-year high, and other nations face a similar issue. Deutsche Bank analyzed inflation in 111 countries and found a median year-over-year inflation rate of 7.9%.

Several world banks have raised interest rates in response. For example, the U.S. Federal Reserve increased its benchmark interest rates three-quarters of a percentage point in June 2022, its most aggressive hike since 1994.

While inflation and interest rates have risen, valuations in some sectors have declined. As of right now, private fund managers are keeping a close eye on which sectors are impacted the most.

Lower overall valuations can make deals more financially attractive, but also make it harder for strategic buyers to use their public stock for acquisitions. This situation gives PE firms, which typically pay in cash, a greater advantage and will likely contribute to more PE deals.

Managers likely to adjust their strategies

While PE managers won’t stop making deals, they will likely adjust which opportunities they pursue this year.

PE managers may find new opportunities as businesses focus on their core brands and divest non-core operations. Dealmakers have already seen many carve-out transactions this year and expect more. In this scenario, PE firms often have an advantage because they don’t face the same antitrust concerns that arise when a business sells to a competitor. Another advantage for PE firms is that sellers prefer to avoid the due diligence a competitor would want to perform on their business units.

Some large and mid-market managers are becoming multi-strategy money managers and setting up separate core and long-term hold platforms and sponsored special purpose acquisition companies. These enable firms to add assets under management with different time horizons.

PE managers may also choose to pursue smaller deals with less risk. Rising inflation leads to stricter underwriting standards, making it more expensive to finance a deal. Because of this, managers might find it more realistic to pursue smaller deals.

Overall, managers in this environment will likely gather more information upfront and be more selective in their dealmaking. That should enable them to move quickly once they identify an advantageous opportunity.

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