Secondaries and mid-market funds shine in tough private equity market.
If investors were expecting the private equity market to pick up in 2024, they will have been disappointed. After a lackluster 2023, overall private equity investment and exit activity has remained challenging since the start of the year.
There were some positives, however.
The mid-market, for example, has been more active than the large enterprise market. This can be explained by the fact that interest rates have remained at a high level. After hovering around 6% for more than ten years, the average yield on LBO loans reached nearly 11% in the United States in 2023, which has made financing company buyout operations more expensive.1. Until now, large- and mega-cap private equity managers have relied on a high proportion of debt in their operations to achieve targeted returns. So, with much more expensive debt, they need the purchase price multiples to fall significantly to maintain similar returns. However, this situation leads to a dead end, as sellers prefer to wait rather than accept lower prices.
Given that almost half of exits are made by private equity fund managers buying from other managers, it is not surprising that exits also declined during the first quarter, although we continued to observe strong output activity. We believe this is the result of our “triple alpha” strategy, which aims to achieve attractive returns by focusing on alpha from three sources – our investment themes, mid-market focus and our process. rigorous investment selection.
Despite the weakness in private equity market activity in recent quarters, average buyout yields have remained positive at around 7.9%. This is lower than equity market returns (in 2023, the MSCI World is up 24%), but the private equity industry has never been about short-term returns and, looking at the long term, the picture is different, with annualised buyout yields totalling 11.6%, compared to 7.1% for the MSCI World. Once again, the mid-market stands out with higher returns of 13.2%.2
Another area of the market that is proving attractive is secondary products. This segment has seen significant growth since pre-Covid and has been the most resilient since the 2021 peak, with market volume declining only slightly from $126 billion in 2021 to $109 billion in 20223. Additionally, secondary fund dry powder remains stable, comparing favorably to other parts of the private equity market. Given the continued glut of exit activity, the supply of secondary deals is expected to remain healthy, suggesting that the market is currently in a good balanced state. We also believe secondary investors will increasingly look to the middle market to seek more attractive returns, given that only 33% of middle market managers surveyed have completed a GP-led deal, compared to 67% of managers large caps.
We believe the secondary market has demonstrated remarkable resilience in the face of a generally challenging private equity market and that the application of our merger strategy – a deliberate balance between GP-led transactions, single LP participations and direct secondaries transactions – provides an attractive option for investors seeking exposure to this growing part of the market.
We aim for concentrated portfolios of high-quality, hand-picked businesses, rather than overly diversified portfolios of multi-line LP holdings. Indeed, the need to leverage these large transactions would delay distributions and further create unwanted “by-catch” – low-quality portfolio companies that are difficult to exit, further delaying distributions and creating negative surprises at the end of the fund’s life. Our strategy is designed to provide investors with accelerated liquidity and high cash multiples without the need for leverage. When we go fishing, we only look for the highest quality fish!
1 Bain
2 Unigestion
3 William Blair
