Structural changes in private and public markets are a natural topic of discussion in large scale private equity conferences like SuperReturn, held in Berlin at the end of February.

Overall, private equity likes to position itself as providing exposure to the types of growth companies not coming to public markets, or at least coming to the market at a much later stage in their corporate cycle as the attractions of public listing diminish.

Some private equity investors even claim the increased focus in private ownership imposes a new long-term perspective with much more private-to-private activity than the traditional private-to-public via an IPO.

General partners (GPs), the reasoning follows, must think beyond their typical five-year horizon and consider what will motivate and attract another GP owner. There are also increasingly more public-to-private deals.

Certainly, private equity is keen to emphasise how it creates value by growing cashflows sustainably; no-one seems to know anyone who drives sustainable long-term value through cost cutting.

Yet some institutional investors look at private equity and see overpriced, leveraged exposure to the same market segments as public equity.

Bain & Company’s Global Private Equity Report 2020, published to coincide with the Berlin event, points out that US buyout funds do comfortably outperform the S&P 500 public market equivalent net of fees over most long-term periods.

But the recent strong performance of public equities has eroded that margin, meaning investors would have been marginally better off investing in the S&P 500 in the 10 years to end-2019.

Commenting on the Bain report at SuperReturn, Kewsong Lee, co-CEO of Carlyle, said: “I think when people look at this report the bigger question is not ‘us versus them’, it’s going to be that we are no longer alternative. We’re mainstream now.”

“I think when people look at this report the bigger question is not ‘us versus them’, it’s going to be that we are no longer alternative. We’re mainstream now”

Kewsong Lee, co-CEO of Carlyle

SuperReturn coincided with late February’s sharp sell-off in equity markets, and few investors assume that equity markets will deliver 15% annual returns again in the near future.

Strong investor demand for private debt funds is one factor helping sustain the now $4trn (€3.5trn) private equity market, which has now seen fundraising top $500m for four years in a row, according to Preqin.

Private debt fundraising in 2019 was somewhat softer than the year before at a little over $100bn, also according to Preqin. But given that the US Federal Reserve and the European Central Bank moved to a ‘lower for longer’ setting in the autumn of last year, and the Fed lowered rates once again in early March, investors’ search for yield in areas like private debt is likely to continue unabated – give or take economic softening due to COVID-19.

The total private debt market now exceeds $800bn – it was up 8% in the first six months of 2019 alone according to Preqin figures – and looks set to expand further in Asia in the longer term.

Questions of the economic cycle were, predictably, a topic of discussion at SuperReturn. As unscientific as they are, conference delegate polls can be a useful gauge of sentiment.

Super Return conference

Questions of the economic cycle were, predictably, a topic of discussion at SuperReturn

On this basis, private debt market participants forecast a slightly higher chance of a recession this year than last, with 56% predicting a downturn in the coming 12-18 months compared to 49% a year before. This pretty much mirrors Preqin survey data for private equity, where 57% of GPs think the market is already at a peak.

The private debt market certainly looks toppy from the perspective of declining covenant terms. This has attracted the attention of the likes of the Financial Stability Board in a report at the end of 2019.

Private debt speakers in Berlin cited the need for managers to pay strong heed to management. Sponsorless deals may look attractive in Europe, for instance, but they often involve family businesses with entrenched management that may be impossible to change or improve.

Aside from making sure capital is locked up in a long dated fund, institutional investors should seek managers with experience of managing assets through the cycle and with capabilities to do more than just desktop due diligence, delegates were told.

With EBITDA add backs so prevalent and covenants so light, managers need to kick the tyres roundly to get their own perspective on the operating cashflows of companies.

This applies to private equity as well as debt of course, and as Michael Arougheti, co founder and CEO of Ares, put it, “every time investors get disconnected from cashflow they lose money”.

“Every time investors get disconnected from cashflow they lose money”

Michael Arougheti, co founder and CEO of Ares

Coronavirus was a peripheral topic at SuperReturn, give or take the preponderance of hand sanitiser at the venue and the cancellation of an Italy-focused private equity stream. But the tone would undoubtedly have been much more sombre had the event taken place at all just a week or so later.

Memories of the 2008-09 financial crisis may be reawakening, and some institutional investors will recall how they were caught out by private equity cash calls when their own liquidity was tight.

Others will remember how anti-cyclical investing paid off when the CLO markets seized up and long-term focused capital was able to pick up bargains as banks were forced to deleverage.

Indeed, LPs like the UK’s Border to Coast local government pension pool are well aware of this. Mark Lyon, head of equities and alternatives at Border to Coast, spoke of the value of deploying capital to private market strategies through a downturn.

As we head into what might be a year of tightening credit conditions and poor market conditions, the wiggle room for investors to take a truly long-term view may be restricted by procyclical regulation.

Unencumbered by leverage, pension fund capital is in a good position if it is able to allocate to private equity and credit prudently over a multi-year and indeed a multi-decade perspective.

Liam Kennedy, Editor