October 2022

Private Equity Performance Across the Cycle

In our June 2022 newsletter, we took a look at the multiyear deployment pace of private equity funds. As just 40% of the capital is deployed over the first three years, we encouraged investors to devise a sound and realistic long-term investment strategy.

We now focus on the performance of vintages across the cycle. Specifically, we look at the high-growth and low-inflation period of 2009-2018 and at the pre–Global Financial Crisis (GFC) years. These two periods contain valuable insights for our investment strategy going forward.

We find empirical evidence that investing through new commitments when the going gets tough and panic is highest, as in the post GFC years, delivers the strongest investment results.

We are now facing a major host of headwinds – inflation levels not seen since the 1970´s, central banks tightening aggressively despite the risk of pushing economies into recession, confrontation between Russia and the West that is threatening our ability to source reliable and affordable energy, and adverse climate that threatens our food supplies. Global and domestic governance are also taking a beating.

In addition, global equity markets1 have declined 25% so far this year. The yields to maturity of sovereign issuers2 have shot up by about 2.5% and those of junk bonds have doubled.

Still, we must maintain the course with our private asset investment strategy. On the one hand, as we saw in our previous note, capital will be deployed gradually over the next six years. On the other hand, investment performance is strongest just after the darkest hours.
Note: Past returns are not necessarily indicative of future results given that the current economic conditions are not comparable to prior conditions, which may not repeat in the future.
Valuation as of June 30th, 2022. North American and European companies in Altamar’s Primary Buyout Funds – primary deals only. Excludes companies in the Debt sector. The sample contains 4010 companies as of 30/06/2022.
MOIC, DPI, RVPI and Realized Capital Loss weighted by invested cost. Buyout multiple (EV/EBITDA), Debt multiple (Net Debt/EBITDA), both entry metrics and median values. Realized Capital Loss calculated as realized loss over total realized cost. 2019-22 Realized capital loss not meaningful (n.m.) given low divestment volume during the period.
Figures refer to the mature Altamar Private Equity, S.G.I.I.C., S.A.U. Commingled funds: ABE, ABG, Altamar V, Altamar VIII & Altamar X.

During the years preceding the GFC, both entry (EV/EBITDA) and leverage (Debt/EBITDA) multiples keep increasing and reached historically high levels. As the crisis hit portfolio companies, portfolio losses reached a staggering 29%. Still, funds3 managed to deliver a multiple on invested capital (MOIC) of 1.5x.

We can appreciate that both entry and leverage multiples settled at lower levels in the aftermath of the GFC. As economies recovered, portfolio losses declined to 8% and exit valuations reached multiples of 2.4x. As a result, private equity funds were able to deliver a MOIC of 2.2x. Capital gains increased by 140% from 0.5x capital gain in the pre-GFC period to 1.2x capital gain thereafter.

Vintages for the period 2015-2018 have been able to continue delivering strong multiples of 2.1x despite the impact of the COVID pandemia starting in early 2020. Exit multiples have averaged 2.4x and portfolio losses 11%.

Looking Forward

What performance can private equity funds expect for the most recent vintages of 2019 to 2021?

On the one hand, entry multiples have again reached record highs as has also been the case with valuations across all major asset classes. On the other hand, leverage is lower than that reached in the pre-GFC years. In addition, interest rates were at rock bottom and covenants were light.

All in, in the context of a worsening macroeconomic environment, we can expect returns lower than in the recent growth years but higher than those delivered in the pre-GFC years. Considering that losses could reach 15 to 20%, we could see MOICs of 1.7x to 1.8x:

Note: Past returns are not necessarily indicative of future results given that the current economic conditions are not comparable to prior conditions, which may not repeat in the future. Valuation as of June 30th, 2022. North American and European companies in Altamar’s Primary Buyout Funds – primary deals only. Excludes companies in the Debt sector. Realized Capital Loss calculated as realized loss over total realized cost. Figures refer to the mature Altamar Private Equity, S.G.I.I.C., S.A.U. Commingled funds: ABE, ABG, Altamar V, Altamar VIII & Altamar X. Valuations as of June 30th, 2022.
“Realised return” corresponds to realized investments excluding written-down investments. “Total return” corresponds to both realized and non-realised investments, including written-down investments.
Moreover, as we have learned, post crisis vintages should lead to more attractive entry valuations and lower leverage for investments, which ultimately should deliver improved returns. For the post COVID 2022 – 2025 vintages, we could expect numbers similar to those following the GFC: a realized gross MOIC in the order of 2.7x, realized losses of 9%, and total returns of 2.2x. The vintage diversification that private equity funds of funds or programs will continue offering precious resilience to sail through troubled waters and still deliver attractive long-term returns4 to investors.
  1. S&P500 performance to 26th September, 2022.
  2. 10y Treasury bond performance to 26th September, 2022
  3. Figures refer to the mature Altamar Private Equity, S.G.I.I.C., S.A.U. Commingled funds: ABE, ABG, Altamar V, Altamar VIII & Altamar X.
  4. For further information, see “Targeting Private Assets”, page 42.

The Operational Resilience of PE Firms

Private assets offer a safe harbor to today´s volatility in traditional 60/40 assets. The resilience of private equity in such environments is not a mirage due to mark-to-model valuations or a growth sector bias.

We find empirical evidence that supports the view that the observed volatility of private equity1 is lower than expected and is a direct result of the embedded operational optionality that renders underlying business activities as inherently less risky.

Private equity, thus, offers bottom-up operational resilience most valuable in the volatile and uncertain times that we face today.

Altamar Private Equity, S.G.I.I.C., S.A.U. private asset funds have clearly outperformed2 public assets during the market meltdown that we have been witnessing since the beginning of the year. Data for the past 12 and 24 months ending in June 2022 reveals a strong and sustained outperformance in both absolute terms and as compared to their public benchmarks:
Note: Past performance is not necessarily indicative of future results, as current economic conditions are not comparable to past performance, which may not be repeated in the future.
“Altamar Funds” data sourced from AltamarCAM’s fund portfolio. “Private Equity, Venture Capital, Infra, Real Estate and Credit: includes all primary and secondary funds managed by Altamar Private Equity, SGIIC SAU for each asset class.
Source: Data for Stock Market Performance obtained from www.Investing.com;
LTM: 30/06/2021 to 30/06/2022; Last 24M: 30/06/2020 to 30/06/2022.

As we all know well by now, these performance 3 numbers are not directly comparable:

  • On the one hand, private assets are valued on a discounted cash flow and / or comparable companies methods (mark-to-model) whereas their public benchmarks are valued on a mark-to-market basis. There is thus a material lag on the time it takes private asset valuations to reflect an adverse market shock. This lag creates a smoothing effect on private equity returns.
  • On the other hand, the sector exposures of private and public assets differ considerably and their relative performance may be significantly different. To illustrate, during the 12 months to June, the USD FTSE World Technology index4 dropped 23%, Telecoms 18% and Health Care 6% whereas the Energy index surged by 14% and Utilities by 1%.

Could there be other fundamental bottom-up reasons as to why private assets outperform public benchmarks during adverse market conditions?

In a Winter 2021 Journal of Alternative Investments article, Private Equity and the Leverage Myth, Czasonis, Kinlaw, Kritzman, and Turkington 5 explore the theoretical and empirical relationship between volatility and leverage.

Their findings:

  • Volatility should scale directly with the degree of leverage.
  • Investors usually estimate the volatility of private equity buyouts by applying a leverage multiple to public equity volatility.
  • Even though private equity firms have twice the leverage of public equity, their observed volatility, even after adjusting for smoothing, is no greater than that of public equities.
  • Leverage has, thus, no apparent effect on private equity volatility. There is no evidence that volatility scales with leverage.

We face a conundrum that would possibly challenge even Greenspan himself.

Czasonis et al undertook to understand the lack of statistical relationship between leverage and private equity metrics. After conducting time-series analyses and reviewing the financial conditions of several companies, they find that leverage is often stable for long periods of time, whereas volatility is highly time-varying, and companies have several sources of implicit leverage.

All in, Czasonis et al  reach the stubborn conclusion that private equity volatility is similar to public equity volatility despite its higher leverage. As they explore why this is the case, they posit that “it could be that buyout fund managers prefer to invest in companies whose underlying business activities are inherently less risky and can therefore bear higher leverage, which increases profit”.

Consistent with Czasonis, J.P. Morgan has introduced this year, in its well-regarded Long-Term Capital Market Assumptions annual study, a novel approach to estimating private equity volatility reflecting the unique characteristics of private market assets – including the embedded operational optionality of private equity. This methodology leads to a dampening of estimated volatility:

In summary, empirical evidence 6 leads us to believe that the lower observed volatility of private equity vs. its public benchmarks is not a valuation mirage but rather the result of embedded operational optionality that renders underlying business activities as inherently less risky.
    1. Information obtained from funds managed by State Street Private Equity Index (page 23 of “Private Equity and the Leverage Myth”).
    2. y 3. Past performance is not necessarily indicative of future results as current economic conditions are not comparable to past performance, which may not be repeated in the future. 4. Data sourced from FTSE All-World Index Series. Monthly review. June 2022
    5. Megan Czasonis, William Kinlaw, Mark Kritzman y David Turkington
    6. Long-Term Capital Market Assumptions (JP Morgan) & Private Equity and the Leverage Myth (Megan Czasonis, William Kinlaw, Mark Kritzman y David Turkington)

IMPORTANT NOTICE:

This document has been prepared by Altamar CAM Partners S.L.  (together with its affiliates “AltamarCAM“) for information and illustrative purposes only, as a general market commentary and it is intended for the exclusive use by its recipient. If you have not received this document from AltamarCAM you should not read, use, copy or disclose it.

The information contained herein reflects, as of the date hereof, the views of AltamarCAM, which may change at any time without notice and with no obligation to update or to ensure that any updates are brought to your attention.

This document is based on sources believed to be reliable and has been prepared with utmost care to avoid it being unclear, ambiguous or misleading. However, no representation or warranty is made as of its truthfulness, accuracy or completeness and you should not rely on it as if it were. AltamarCAM does not accept any responsibility for the information contained in this document.

This document may contain projections, expectations, estimates, opinions or subjective judgments that must be interpreted as such and never as a representation or warranty of results, returns or profits, present or future. To the extent that this document contains statements about future performance such statements are forward looking and subject to a number of risks and uncertainties.  

This document is a general market commentary only, and should not be construed as any form of regulated advice, investment offer, solicitation or recommendation. Alternative investments can be highly illiquid, are speculative and may not be suitable for all investors. Investing in alternative investments is only intended for experienced and sophisticated investors who are willing to bear the high economic risks associated with such an investment. Prospective investors of any alternative investment should refer to the specific fund prospectus and regulations which will describe the specific risks and considerations associated with a specific alternative investment. Investors should carefully review and consider potential risks before investing. No person or entity who receives this document should take an investment decision without receiving previous legal, tax and financial advice on a particularized basis.

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