Can private equity bounce back?

Private Equity Market Performance and Outlook

• Recent Returns vs. Public Markets

  • Year-to-date private equity returns hover between 2% and 3%, significantly trailing public equity indices (S&P 500 up nearly 10% YTD).
  • Over the past 2.5 years (through end-2021), cumulative private equity returns reached approximately 15%, outperforming equal-weighted public market returns.
  • Pre-rate hike returns (2020–2022) were exceptionally robust, making it difficult to return to the typical 15% to 20% net IRR targets.
  • Goldman Sachs projects private equity returns will remain "more subdued" over the next two to three years compared to historical averages.

• Capital Deployment and "Dry Powder"

  • Global "dry powder" (uninvested capital commitments) stands at a record $2.5 trillion, representing approximately $5 trillion in total purchasing power including leverage.
  • Deployment pace slowed significantly in 2023 to roughly 40% of available capital, a sharp decline from the 70% deployment rates seen in 2021–2022.
  • The slow deployment is driven by two primary factors:
    • An oversupply of capital relative to investment opportunities ("too much capital chasing too few").
    • A persistent bid-ask spread between buyers and sellers, though this gap is narrowing as credit spreads tighten.
  • In 2023, the industry raised only $700 billion, the lowest annual fundraising total since 2017.

• Fundraising Constraints

  • The "denominator effect" has caused institutional investors to appear over-allocated to private markets due to underperformance in public markets, necessitating a pause in new commitments.
  • Capital return to Limited Partners (LPs) has been constrained by a low pace of realizations (exits), delaying the ability to make new investments.
  • Corporate private equity has faced particular difficulty in raising capital compared to other strategies over the last two years.

• Future Growth and Capital Sources

  • The industry has overgrown, accelerating from a 15% annual growth rate to 30% during 2021–2022; future growth is expected to normalize to slower, sustainable rates.
  • U.S. pension plans are nearing full allocation, shifting the focus for new capital to:
    • International markets, specifically Asia and the Middle East.
    • The wealth management sector and high-net-worth individuals, who remain significantly under-allocated to private markets.
  • Product innovation is underway to address retail accessibility, including semi-liquid vehicles offering low single-digit liquidity versus traditional 10-year lock-ups.

• Competitive Landscape and Asset Shifts

  • Private credit is gaining market share from private equity, offering double-digit senior returns with lower risk, narrowing the risk-adjusted return spread.
  • Private infrastructure is also seeing increased focus as an alternative to traditional private equity allocations.
  • Future success is predicted to rely on three pillars: diversification across asset classes, global presence (non-U.S. capital), and wealth management channel access.
  • Market consolidation is accelerating, with larger, diversified firms better positioned to survive than monoline private equity firms.

Deal-Making Dynamics and Transaction Strategies

• Valuation and Deal Environment

  • The valuation gap between buyers and sellers has narrowed as market participants adjusted to a higher cost of capital, leading to more realistic transaction multiples.
  • Transaction activity remains sluggish but is expected to pick up as interest rate uncertainty decreases and financing becomes more available.
  • Public-to-private (going private) deals are increasing, with sponsors capitalizing on valuation dislocations between public and private markets where IPO windows are closed.

• Exit Strategies and Liquidity

  • Traditional IPO exits have slowed significantly, forcing sponsors to adopt alternative liquidity solutions.
  • The secondary market for private assets is estimated at over $100 billion annually and is growing, providing an essential outlet for LP liquidity.
  • GP-led continuation funds are increasingly used to allow sponsors to hold well-performing assets longer while providing liquidity to existing LPs.
  • Net Asset Value (NAV) financing is rising as a tool to fund distributions and strategic add-ons without selling underlying assets.

• Strategic Evolution of Firms

  • Firms are moving toward multi-asset platforms, acquiring capabilities in credit and infrastructure to diversify revenue streams and fees.
  • Future deal-making will emphasize "manufacturing returns" through operational value creation rather than relying on financial leverage or multiple expansion.
  • Deal structures are becoming more creative, featuring minority stakes, co-control arrangements, and structured equity solutions to navigate the current rate environment.

Forward-Looking Statements and Industry Cycles

• Cyclical Context

  • Goldman Sachs views the current environment as a normal cyclical reversion following the post-2008 boom and the ultra-low rate acceleration of 2020–2022.
  • The industry is described as "mature," with a slower but continued long-term growth trajectory expected over the next decade.
  • A return to "flywheel" momentum is contingent on two factors: a clear path to lower interest rates and more well-functioning capital markets that facilitate liquidity.

• Manager Dispersion

  • A widening dispersion in performance is expected, where returns over the next three to four years will dictate which managers can successfully raise subsequent fund vintages (2026–2028).
  • Success will increasingly favor firms with global reach and diversified capabilities over those focused solely on U.S. private equity.
  • The industry anticipates that the need for liquidity will drive continued innovation in secondary markets and structured finance solutions.