Navigating the Private Equity Seas in 2024

In 2023, against a backdrop of economic ups and downs and dynamic market trends, the private equity scene felt the aftermath of the previous year. High-interest rates in late 2022 made deals and financing tough, impacting private equity performance.

For the first half of 2022, things looked good for completing business deals, but later on, interest rates surged, causing problems. This made it hard for companies to make agreements in deal exits, and things got even tougher in 2023. There were some big bank failures, and many people lost their jobs.

Investing money was tricky during this time. Both bonds and stocks had a tough year in 2022 because of slow economic growth, and there was not enough money to borrow. As interest rates rose, it became harder for businesses that rely on borrowing money, like tech and energy companies, to get the cash they needed.

While interest rates kept going up, people put more money into safer investments that tend to give good returns, like money market funds. These funds now hold a record $6 trillion.

In 2023, borrowing money became even more expensive, and it took longer for companies to sell their businesses because of all the uncertainty in the market.

But there's hope for 2024—it looks like interest rates may stop increasing, making it easier for companies to carry out deals and investments due to more liquidity in the system, benefiting overall economic activity.

In this article, we explore how these factors connect with current economic conditions, shedding light on the state of private equity in 2023 while also projecting potential developments for 2024.

How 2022's Market Constraints Impact Deal-Making Today

Even after a thorough analysis of market indicators, it ultimately boils down to whether confidence kickstarts private markets or if fear stifling activity; the performance of one asset class often sets the tone for others. For example, when bonds performed poorly in 2022, investors sought safer investments like treasuries, resulting in record inflows.

Investors often chase high yields in uncertain market conditions, especially amid fears of an economic downturn and uncertainty about Federal Reserve action on interest rates. This uncertainty can make borrowing from banks challenging due to limited liquidity.

Even among the more resilient asset classes like technology and healthcare, none are exempt from the repercussions of interest rate fluctuations. Interest rates are crucial in determining overall economic activity and the number of deals made during a specific time frame by influencing the cost of borrowing money. When interest rates are low, borrowing is cheaper, encouraging more investment and economic activity. On the other hand, high-interest rates increase borrowing costs, leading to fewer deals and slower economic growth.

Rising interest rates had a pronounced effect on dealmaking dynamics in 2022 and 2023, particularly in the world of leveraged transactions, such as loans and credits from big entities. As interest rates went up, the banks' reluctance to lend also went up.

Higher interest rates also led to less bond issuance in public markets, so investors turned to private capital instead. Bond activity dropped by 78% from 2021 to 2022, making it the worst year on record.

Also, institutional investors decided to go with larger, well-known funds in private equity, causing a concentration of capital. The top five managers received almost 30% of all fundraising, a decade-high share. The IPO market, another indicator that reveals overall health and sentiment in private markets, nearly shut down in 2022 and 2023 due to general volatility in the market.

So, how did this impact the trends we see today?

In private equity markets, activity is typically measured by deal volume, fundraising, exits, and investment performance. These indicators help investors identify market trends, gauge confidence levels in the market, and make well-informed decisions.

In 2022, private equity faced some challenges, but it also showed resilience. Tech-related stocks like Microsoft and Apple saw a 30% drop in value, affecting the stock market. Deals, exits, and fundraising took a hit in the second half of the year, yet it still managed to be the second-best year overall.

Moving into 2023, dealmakers became more cautious. There's been a noticeable decline in the number of managers involved in buyout funds and a significant drop in fundraising compared to the previous year. Despite this, there's a lot of capital available for investing.

2023 ended with $2.6 trillion of available funds for investing, but challenges in closing deals and market uncertainty pose significant challenges to their deployment. Moving into 2024, investors and businesses will be closely watching interest rates and the direction of the economy to guide their decisions, especially gross domestic product (GDP) numbers, which are key indicators of economic health and activity.

Focus Industries for 2024

Despite investor speculation about rising interest rates, some industries have demonstrated greater resilience in managing through periods of high-interest rates. Examples include technology, healthcare, renewable energy, and infrastructure.

Tech and healthcare saw valuation increases due to strong market demand. Also, on a bullish sentiment, the shift towards renewable energy is expected to drive significant private investment in the coming decades.

Global infrastructure markets, including transportation, energy, and communications, are undergoing significant changes. These involve advancing digitization, reducing reliance on fossil fuels, and regionalizing supply chains. As a result, there's a growing need for new digital, environmental, and industrial infrastructure.

However, there's a substantial gap between infrastructure investments and the required capital. Although fundraising in sectors like natural resources and infrastructure hit record levels in 2022, there's still a significant need for additional financing. Meanwhile, macroeconomic factors such as higher energy prices and geopolitical tensions fuel investor interest in alternative energy sources, sustainability, and energy independence.

On the other end of the spectrum, industries like traditional retail, hospitality, travel, and commercial real estate faced declining valuations, even after recovering from COVID lockdowns. Until valuations improve or assets have time to recover, the outlook for deal activity in private equity remains uncertain until the early half of 2024.

Strategic Moves Amid Market Changes

In light of ever-changing trends, staying ahead in private markets requires keen observation of directions and tendencies. Market fluctuations are perpetual, and keeping a close eye can offer foresight and opportunities for profit. Reading the right signals and adapting to market phases is key for participants. Consider the following:

• Completing deals in a downturn usually yields better long-term returns. Unlike an upward market phase, downturns can be profitable due to lower valuations and reduced competition. If the macro factors are accounted for, leaders can confidently underwrite deals of their liking, which have more value in a constrained liquidity scenario.
• If a deal has a good asset at a good price in sight, it may be worth it to take higher debt or equity. GPs should prioritize acquiring valuable assets at reasonable prices, knowing that balancing finances can be done later. Delaying decisions risks missing profitable opportunities from a potential rebound.
• Excessive reactions can be detrimental. Preparing companies for success is crucial. When the economic cycle shifts, the instinct to liquidate assets within portfolio companies and drastically cut expenses arises. While this might temporarily protect the financial status, it inevitably hampers overall performance. Although it's prudent to save money, access credit lines, and fortify reserves to weather a recession, it's equally vital to seek opportunities to maintain an offensive strategy.
  

2024 Private Equity: Adapting to Economic Shifts

There is potential to realize strong returns in the foreseeable future. Periods of economic stress and volatility require a moderate, calculated extra boldness that can pay out in the long run by outperforming the competition. This dynamic has played out across different market cycles.

This year could prove to be a favorable time to invest in core private equity based on indications of a gradual slowdown in the U.S. economy. With asset valuations in private markets usually tending to follow behind those in public markets, prices for prominent private industries will likely become lower and more reasonable for managers looking to put their money to work. PE managers currently have a wide funding volume to offer because of the accumulated dry powder. This, in turn, will benefit deal activity in 2024.

On a more macro scope of things, if the Federal Reserve successfully orchestrates a soft landing for the U.S. in 2024, it could be a favorable year for private markets, especially in artificial intelligence and value creation sectors. It could also mean it's a convenient time to explore and tap into alternative investments such as infrastructure or commodities.

According to this Le Monde article, the primary threat to the economy in 2024 will be geopolitics. If a recession happens to hit the US in 2024, massive interest-rate cuts should be expected. If lower interest rates occur, it will make loans cheaper, expanding the money supply and making risk-on assets like Bitcoin, bonds, stocks, and gold absorb newfound liquidity, driving its price to new heights in 2024.

Overall, the private equity industry remains well-built for long-term growth and prosperity. However, the economic slowdown will definitely present potential headwinds for 2024, but the shock is nothing the private industry hasn't weathered before. It remains to be seen whether private equity valuations will resemble the declining performances in public markets in 2024.

Bottom line: experts agree that the chances of a 2024 recession are far lower than they were for 2023, this time last year.

The information provided is for educational purposes only and should not be construed as financial advice; individuals should consult with a qualified financial advisor before making any investment decisions.

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