A pair of private equity fund studies has recently raised expectations for a sustained recovery in the market, but private equity professionals shouldn’t get their hopes up just yet.
Cambridge Associates found that private equity funds returned 4.3 percent in the second quarter, the first positive increase since 2007. Meanwhile, State Street found that average private equity fund valuations were written up by 5.48 percent in the second quarter, again for the first time since 2007.
According to Cambridge, the private equity index’s gains were largely the result of improved valuations for companies in several industries hardest hit by the recession, while general partners made about $1.1 billion more capital calls in the second quarter than the first quarter.
Meanwhile, the more than 5 percent uptick in write-ups reported by State Street in the second quarter came after five straight quarters of losses. While it could be taken as a sign that private equity fund performances are beginning a sustained increase, recent history argues otherwise.
State Street Private Edge Group's Jason Mao says the Q2 surge in 2009 was more likely a temporary bounce in reaction to the severe write-downs in previous quarters. Fund valuations decreased by 6.46 percent in Q1 2009 and a whopping 16.32 percent in Q4 2008.
In addition, a historical comparison with the last major recession in 2001-2002 indicates the industry may have to hit another economic “bottom” before a proper recovery. Following the dotcom crash the private equity industry experienced a “W-shaped” recovery, first hitting a bottom in Q4 2001 – when quarterly returns fell by 3.11 percent – then recovering before hitting a second bottom of -5.50 percent in Q3 2002.
It was after the Q3 drop in valuations that the industry began seeing a sustained recovery. The biggest difference between now and the 2001-2002 period is the fact that private equity firms are sitting on about $500 billion in unfunded commitments waiting to be deployed.
A “V-style” recovery that would see significant, continued gains in Q3 of this year and beyond could be driven by new investments, as well as more IPO opportunities and M&A activities. But the fact that managers are largely not deploying their dry powder, perhaps because they anticipate another economic bottom, may make a “W-style” recovery even more of a certainty.