In a recent ‘Investment Warnings’ piece on the private equity market, here on The Value Perspective, we suggested some investors had grown a little too comfortable with the record-high levels of debt in that sector, with risk awareness slipping ever further down investors’ list of priorities as the hunt for returns becomes all-consuming.
Still, if that is where the sector is now, how has it reached this point?
Bain & Company’s 2019 Global Private Equity Report, proposes some possible answers.
Exit activity from private equity deals continues to be strong, it notes – the $2 trillion (£1.59 trillion) generated since 2014 is easily the largest five-year total on record – and this has led to a steady flow of capital heading back towards private equity businesses.
Indeed, as the report points out, investors were “cashflow-positive” – that is, distributions outstripped contributions – for the eighth year running in 2018, creating “a virtuous cycle” that has encouraged businesses to continue “pumping capital back into the industry”.
To offer one arresting number as an illustration, private equity firms have raised $367bn for early-stage healthcare and technology investments since 2014.
And here are a couple of even more eye-popping figures from the report: global financial capital increased 53% from 2000 to 2010, reaching some $600 trillion – or 10x real global gross domestic product – while, since the start of the current economic cycle in 2009, “investors have allocated a staggering $5.8 trillion globally to private equity, and the debt markets have been eager to finance transactions”.
Capital flows into private markets are quite simply, as the Bain analysts note, unprecedented – partly because investors have more money to put to work than ever before and partly because “financial engineering, high-speed computing and the loosening of financial regulations have unleashed a superabundance of financial assets over the past 25 years, which has transformed how both the equity and debt markets behave”.
The upshot of all this, according to Bain, is that private equity firms are now of the view their major challenge is keeping up with their gains while market analysts are now “almost unanimous” in their view that private equity’s track record will continue. Contrarians that we are, here on The Value Perspective, unanimity is something about which we are inherently suspicious.
But here’s a funny thing – Bain’s fascinating insight into one way investors are hunting for returns in today’s cheap-money world offers this pithy little conclusion: “The key imperative in cyclical deals is a deep understanding of how well a company is positioned financially and competitively. It isn’t enough to know the industry well; in diligence, firms need to test the business against robust downturn scenarios.
“This means having a firm grasp of how far earnings can fall and for how long, and exactly what levers an owner can pull to minimise the damage. It is essential to build a balance sheet that can withstand a period of economic weakness.”
In other words, this report into one of the growthiest of growth sectors in all of investment offers a deeply value-oriented conclusion expressing sentiments with which regular visitors to The Value Perspective will be very familiar.