In 2024, private equity will be a waiting game

In 2024, private equity businesses were forced to wait.

Private equity managers, who have been waiting for the cycle of rising rates to peak and for an improved understanding of pricing risks, have responded favourably to falling interest rates and rising stock market valuations.

The much-anticipated “pent-up demand” in M&A and buyout activity, which was supposed to spur a spike in dealmaking, hasn’t precisely materialized at the scale management hoped for, even though the macroeconomic environment has improved during the year.

According to data from legal firm White & Case and Dealogic, the value of buyout deals worldwide has increased year over year, increasing by more than a third to $637.02 billion during the first nine months of 2024.

However, the increase in deal value must be considered in perspective. The value of buyout deals has been falling for the past two years, and while deal activity increased in 2024, it is still far below the levels attained during the market’s peak in 2021.

When looking at exit value numbers, the industry’s continued struggles to recover fully are evident. The global departure value at the end of Q3 2024 was about one-third lower than the numbers for the same period the previous year. The single largest obstacle facing private equity firms in 2024 has remained landing exits at acceptable values, just as it was in 2023.

Fundraising has been continuously impacted by tepid exit markets, which have resulted in smaller payments to investors.

PEI data shows that during the first three quarters of 2024, private equity financing dropped to its lowest levels in four years. In the meantime, a tiny group of powerful managers has absorbed a considerable portion of the available cash. According to data from Bain & Co., the ten most considerable buyout funds that closed during the calendar year ending in mid-May 2024 were responsible for about two-thirds (64 per cent) of the capital raised.

Due to limited liquidity and dividends, LPs have allocated their capital to prominent, reliable managers who provide size and downside risk protection. Longer fundraisings have resulted for managers outside of this cohort; according to PEI, funds that closed in 2024 took an average of 19 months, more than twice as long as it took to reach a final close in 2020.

By finding liquidity options outside of conventional exit routes, managers have shown the asset class’s inventiveness and increasing complexity in an attempt to jumpstart distributions and, ideally, financing.

Secondaries, the primary source of liquidity in an illiquid asset class, have prospered in a cash-constrained setting and given managers and investors in need of cash a vital supply of capital. Jefferies reports that the value of secondary deals increased by 58 per cent compared to 2023 statistics for the same period, reaching an all-time high of $68 billion. GP-led and LP-led deals had double-digit year-over-year improvements in the first half of 2024.

GPs looking for different levers to generate distributions now have more options thanks to financing markets.

According to research from NAV finance provider 17Capital, the market more than doubled between 2020 and 2023, demonstrating the fantastic expansion of this once-niche product sector since the turn of the decade.

In addition to providing additional capital to portfolio companies in funds that have exited investment periods, NAV finance—loans given at the fund level against the value of portfolio companies in funds—has also been used to release liquidity in unsold portfolio companies and distribute funds to investors.

Managers have also shown their proficiency with leveraged finance markets to speed up liquidity. As interest rates decline and lenders seek ways to use their capital, dividend recaps—in which debt issuers borrow to pay dividends—are once again an option.

Although the major driver of private equity dividends and fundraisings will be the reopening of primary exit routes, managers, lenders, and advisers have shown in 2024 that the asset class is flexible and can innovate and adapt during difficult times.

2024 private debt outlook: stable

Following a remarkable 2023, private debt maintained its impressive performance in 2024 by continuing to draw in investors and offer alluring risk-adjusted returns.

In contrast to a private equity market where fundraising has been muted, private debt fundraising has been strong throughout 2024. According to data from Private Debt Investor, private debt fundraising for the first three quarters of 2024 was slightly lower than figures for the same period in 2023.

Resilient private credit portfolios and strong returns have propelled steady fundraising. For instance, Morgan Stanley data shows that between the start of 2008 and the end of Q3 2023, direct lending methods produced average returns of 11.6%, surpassing both high-yield bonds (6.8%) and leveraged loans (5%).

Additionally, portfolios have fared well during the cycle of rising interest rates. According to research by the law firm Proskauer, which monitors 872 senior secured and unitranche loans totalling US$152 billion, the aggregate private credit default rate was only 1.95 per cent in Q3 2024, despite the fact that defaults have somewhat increased as interest rates have risen.

The capacity of private credit managers to collaborate with management teams and financial sponsors to guide credits through uncertain times and preserve value is demonstrated by the fact that losses have been reduced to a minimum through high interest rates.

Consistent returns and the control of downside risk demonstrate the effectiveness of the private credit model in general. Managers devote time and resources to thoroughly due diligence prospective credits, maintain comparatively small but high-quality portfolios, and work closely with portfolio credits during hold periods.

But in 2024, private credit hasn’t had it all. Over the year, the reopening of broadly syndicated loans (BSL) has increased competition and put private credit’s market share under pressure.

BSL markets, essentially shut down for the past year, have come alive again as interest rates have decreased throughout the year. According to White & Case data, the number of leveraged loans issued in the US and Europe in the first nine months of 2024 nearly doubled annually.

Leveraged loan markets have been able to recoup businesses that went to private debt managers during the first round of interest rate hikes by refinancing unitranche loans issued by private debt managers at lower rates due to their lower cost of capital.

According to Bank of America data reported by Bloomberg, at least 70 private debt transactions totaling almost US$30 billion have been refinanced at reduced rates in the BSL market.

Given the projected returns for investors, private debt funds have had to reduce their margins to compete with the lower cost of financing provided by BSL markets. This has restricted the range of opportunities that managers can explore.

By providing customizable loan packages, quick execution, and lower syndication risk, private credit lenders can still set themselves apart from the competition. Although price is not the only consideration for borrowers when selecting a financing option, managers must sharpen their pencils to maintain the lowest possible margins as the BSL market becomes more competitive.

2024’s tangible assets: areas of opportunity

In 2024, real asset managers and investors have remained cautious despite declining inflation and interest rate reductions.

In fact, throughout the year, there has been little fundraising for infrastructure and real estate funds. According to PERE data, over the first nine months of the year, real estate fundraising fell by more than a third compared to last year. Fundraising for infrastructure has been more consistent. Infrastructure Investor reports that year-over-year fundraising increased for the first three quarters of 2024 but cautions that full-year figures may still fall short of the 2023 annual total because of a spike in activity in the last quarter of 2023 that may be hard to duplicate.

Despite improvements in macroeconomic fundamentals throughout the year, managers and investors have remained patient, awaiting a better understanding of how the outcome of a US presidential election and escalating international tensions may affect tangible assets in the long run.

Although volatility has persisted, there have been signs of improvement in the real estate market in the second half of the year, according to JLL. Dealmakers felt more confident about moving forward with new deals due to lower debt costs and more pricing data points.

The most significant recoveries in deal activity have been observed in large, developed real estate markets, particularly the US and the UK . JLL has observed that consumer-facing sectors, including retail, real estate and hospitality, have benefited from better macroeconomic conditions. While logistics activity has been more restrained, with corporates examining supply chain dynamics and existing footprints before expanding into new space, office real estate has stabilized as businesses shift back to more office work.

Meanwhile, deal activity has also differed by subsector in the infrastructure sector. According to CBRE, while total infrastructure M&A activity decreased year over year in the first half of 2024, there were notable year-over-year increases in a few verticals, including transportation and power.

Data centres and decarbonization have been two megatrends that have continued to drive real estate and infrastructure fundraising and deal activity.

Investment in data centres has barely skipped a beat through rising interest rates. Despite broader macroeconomic dislocation, the massive demand for data to power digitalization and AI sustains data centre build-outs. According to JLL, the colocation data centre market in the US alone has more than doubled in size during the last four years, supporting ongoing M&A and debt financing transaction opportunities.

Conversely, real estate investors have made decarbonization a top goal because they understand how critical it is to cut emissions in the industry, which CBRE estimates contributes 40% of world emissions.

Decarbonization has emerged as a regulatory and compliance need with new frameworks like the Sustainable Finance Disclosure Regulation (SFDR) and the gradual implementation of stricter real estate energy efficiency standards.

The private sector will need to contribute significantly to the transition to cleaner, lower-emission buildings, which will also allow developers and investors to create unique real estate portfolios that could yield larger returns.

In 2025, real asset managers and investors will still rely on these two megatrends to propel portfolio performance, but they also hope that lower interest rates will benefit other asset-class sectors.

Please contact us immediately at GERAI LTD with any questions.