Key Issues in PE – 2024

 

  • Number of PE Funds up 5x in the past 30 years
    • In the late 1990s, there were < 1,000 PE funds (LBO) in the US. The number of PE funds has since grown to 5,000+ all chasing a few good deals
  • AUM is up 44x
    • PE assets under management (AUM) have experienced significant growth – in the 1990s PE AUM was relatively modest, with the industry managing around $100 billion globally. As of recent years, PE AUM has exceeded $4.4 trillion globally – this is a 44x increase from the PE AUM in the 1990s
    • Projections indicate that this growth trajectory will continue – according to PitchBook, global private capital AUM is expected to reach nearly $20 trillion by 2028
    • And over the next 20 years, inflow of private wealth and retail capital into PE will fuel AUM growth even more, creating intense competition chasing select quality deals
  • Increase in Average Holding Period
    • According to Prequin, the average holding duration has gone up by 40%+ from 5 years to 7.1 years in the past decade
    • High prior valuations and current economic environment make it harder for PE funds to hit target returns quickly, leading to longer holds
  • Interest Rates – 20x jump since 2020 (after a 2,000 bps decline over the prior 40 years)
    • Since 1981, the rates have been in decline by ~2,000 bps to 2020 when the Federal Reserve reduced the federal funds rate to a target range of 0.00% to 0.25% in March 2020
    • The Fed implemented a series of rate hikes starting in Q1’22 (with similar moves by other central banks globally), responding to inflationary pressures and aiming to stabilize the economy – Fed implemented a series of rate hikes starting in March 2022, with similar moves by other central banks globally, responding to inflationary pressures and aiming to stabilize the economy
    • The increase from ~0.25% in 2020 to 5% (Fed’s initiated rate hikes culminated in a peak target range of 5.25% to 5.50% by July 2023) represented a 20x+ increase in the federal funds rate since its low in 2020 ​
    • Today, SOFR plus an additional credit spread or margin for buyouts (SOFT + 400 / + 500 or more) is resulting in an all-in interest rate that is very high and makes it much harder to hit target IRR returns
  • Less “L” in LBOs
    • Due to high interest rates, there is a lot less “L” in LBOs today
    • This implies that most of the value creation in PE will need to come from tangibly impacting company growth and operational improvements
  • Not a Lot of Distributions in the Age of “DPI is the New IRR”
    • Distributions to Paid-In (DPI) now outshines Internal Rate of Return (IRR) as the primary measure of success, with LPs seeking realized returns over paper gains and so far there are too few in PE

What does this mean for the PE firms over the next 20 years?

To succeed, PE firms must now differentiate through genuine value creation, as they face intense competition, longer holding periods, and high-interest rates that limit leverage. Firms must focus on driving operational improvements and growth within portfolio companies to meet investor expectations, as LPs increasingly prioritize tangible distributions (DPI) over speculative IRR gains.