From lower fundraising totals to its first negative returns performance since 2008, private equity “fell back to earth in 2022”, according to a report from McKinsey & Company.
“Is there more pain to come in future? It is hard to say,” Brian Vickery, a partner at McKinsey, told Private Equity International.
“It’s hard to know how the lag in reporting in PE intersects with what are often higher-quality companies whose fundamentals may not have changed all that much. And, public market comparables actually turned positive in the fourth quarter and through the first couple of months of 2023,” he added.
“We also have to factor in the macroeconomic environment, and that’s going to have a lot to do with the fundamentals of the businesses.”
PE returns fell to negative 9.2 percent in the year to September 2022, making it its worst year since 2008. “Because of the deterioration in technology valuations, VC and growth equity returns led the fall, in stark contrast to the last several years,” according to McKinsey’s Global Private Markets Review 2023. “The median growth and VC funds lost 6.3 and 7.3 percent, respectively, through the first three quarters of 2022, while the median buyout fund earned 0.9 percent.”
All private markets asset classes recorded lower returns in 2022 than the previous year, although PE was the only asset class to generate negative performance.
The slump was also evident in capital raising and deal activity. PE fundraising fell 15 percent to $655 billion, its lowest level since 2017. Global private equity deal volume declined 26 percent year-on-year to $2.4 trillion, and deal count dropped 15 percent to just under 60,000, according to the report.
“We’ve talked for years about there being an overhang, a tailwind of capital in private markets with so many investors underweight [to] their targets. That gap closed last year,” Vickery noted.
“The share of fundraising going to the top 25, top 50 managers hasn’t changed in a decade. Last year was a real separation, in that the concentration of dollars with the largest managers was substantially higher in 2022 than it has been in a long time.”
The report found that funds over $5 billion collected a record $445 billion in aggregate last year, up 51 percent over funds of a similar size in 2021. Meanwhile, capital raised by funds smaller than $5 billion slid by 28 percent, and first-time fund launches fell by 40 percent year-on-year.
Scaling private debt
Private debt set a new capital-raising record at $224 billion, up 2.1 percent from 2021 and exceeding $200 billion in fundraising for the second year in a row, according to the report. The asset class “stepped into the void to finance PE transactions”.
Data from Refinitiv cited in the report estimated that direct lenders accounted for about 80 percent of the sponsored mid-market volumes in the second half of 2022.
John Spivey, an associate partner at McKinsey, noted that as private credit lenders scale, they will be more and more capable of disintermediating traditional syndicated or high-yield channels for larger borrowers.
“That’s been a boon to private equity when bank financing has been hard to come by. We saw that in the last year… When the traditional financing markets are closed, the fact that the private credit market has matured so much over the past five or 10 years has been really helpful to keep the wheels turning for private equity.”
The asset class remains a robust offering across both down cycles and expansionary cycles, Spivey pointed out.
He noted a few reasons for this. “One, certain private credit strategies – distressed and special situations – actually have greater deployment opportunities and greater return potential when times are tough. Second is its relatively stable return profile and insulated position from valuation volatility. And third is the fact that much of it is floating rate and therefore provides built-in protection from inflation and rising rates. So, in many ways, it’s tailor-made for the current environment.
“There are a lot of things going on right now that puts private credit in a very good position, and GPs are attempting to capitalise on that,” he said.