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by Alex Bozoglou, Head of Investments
As we take our first steps into 2023, it feels like a natural time to reflect on private markets’ journey through 2022 and to begin to map out the possibilities for the year ahead. Below, we take stock of recent events and market movements, and consider how they could influence performance over the coming months.
A look back at the way we've come
That last year was tumultuous for the global economy, geopolitics and financial markets is undeniable. Indeed, dictionary-publisher Collins has chosen “Permacrisis, a term that describes ‘an extended period of instability and insecurity,’” as its word of the year. From rapidly rising inflation and interest rates to Russia’s war in Ukraine and faltering global growth, the route through 2022 was, for many investors, very difficult to navigate. Volatility was evident in both public equity markets and in bond yields, while some of the effects also filtered through to private markets.
Uneven impacts on private equity’s sub-asset classes
It’s clear that the overall pace of private equity investment slowed during 2022, following a stellar year in 2021. The growth equity segment decelerated most, with valuations also dropping sharply. Given growth equity’s closer correlation to public markets, this was not unexpected.
Venture capital (VC) investment slowed significantly, too. The best companies had already taken advantage of fertile conditions in 2021 to secure capital. On average, cash reserves in this area remain strong and a focus on cash burn reduction has increased runways. This reduces the need to raise more money. While VC valuations fell in 2022, they may have further to drop in 2023 before stabilising.
With monetary policy tightening and higher interest rates acting as a brake on debt financing, much fewer large and mega buyout deals were completed in the latter half of 2022. Only a select few of the highest quality deals took place with valuations comparable to those of 2021.
By contrast, the small/mid buyout segment, which relies less on debt financing and where there is often a need to transact, was relatively robust. Here, capital deployed at a pace similar to that of 2021.
Overall, buyout prices adjusted over the 12 months, with small/mid valuations undergoing the swiftest change. For PE as a whole, unprofitable companies suffered sharper declines as investors sought out more resilient assets. In particular, B2B (business-to-business) models with well-diversified revenues and predictable cash flows have shown greater tenacity.
Fundraising takes a breather
There was also a golden spell for fundraising two years ago:: volumes in 2021 surpassed the previous peak of 2007-2008. Such was the number of funds out in the market, that general partners (GPs) had to significantly extend timescales, as some limited partners (LPs) were overwhelmed and unable to extend their allocations sufficiently to invest in new offerings.
In combination with 2022’s macroeconomic headwinds and technology sell-off, this trend is causing institutional LPs to consider one or more of the following paths:
· reducing the number of GP relationships
· downsizing their commitments
· selling fund stakes on the secondary markets to fund re-ups.
What’s on the horizon?
As a result of the factors above, we expect fundraising to be muted in 2023. The recent slowdown in deployment for venture, growth and mega and large buyout funds, combined with the strong fundraising in prior years, will also reduce the number of offerings from GPs this year.
Turning to valuations, we anticipate that VC prices will decline further, perhaps bottoming out in the second half. On the other hand, we have already witnessed a significant adjustment in growth equity valuations and we feel that these are less likely to deteriorate considerably in the coming months. As we noted earlier, buyout pricing has seen some declines, which were more pronounced in the small and mid-market segment.
These market conditions could create significant opportunities in the next few years. From a sector perspective, for example, technology and healthcare will continue to experience long-term secular tailwinds. We discuss the subject of technology and its place as a driver of global economic growth in more detail in our recent article: Technology – why change is here to stay.
Healthcare, too, benefits from long-term drivers. These include the increased demand arising from ageing populations and persistent innovation and digitisation. For both tech and healthcare, relative resistance to prevailing market conditions could be an important factor in their ability to withstand rising inflation.
Investors may also increasingly look to private credit to counter inflation’s effects. Typically loans are floating rate instruments, which can provide a hedge against inflation and interest rate increases.
In summary, we believe the correction seen in 2022 could provide investment opportunities in 2023. History has shown that times such as these have the potential to demonstrate investment outperformance. Should investors maintain a long-term horizon and thoughtfully diversify their portfolios, this could be the case once again.
Author
Alex Bozoglou, Head of Investments
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