New avenues for growth
However, as more capital flows into the asset class, PE firms will be increasingly challenged to deploy it.
While the traditional buyout space will remain core to PE, some of the industry’s most attractive opportunities will come from segments of the market that are less well-developed.
- Opportunities outside the US and Europe, where penetration is much lower
PE activity in the emerging markets has seen tremendous, albeit uneven, growth. According to data from the Emerging Markets Private Equity Association (EMPEA), activity in the emerging markets represented 23% of global PE investment activity in 2018, up from just 9% a decade ago. Powerful secular trends, including a growing middle class, an emerging consumer culture and strong demographics, make the emerging markets one of the industry’s clearest growth opportunities. In the US and UK, for example, average annual PE investment activity represents 1.7% and 2.1%, of GDP, respectively. In emerging markets such as India, China, Brazil, and sub-Saharan Africa, the penetration rate of PE is far lower – just 0.36% in India, and 0.16 in China, for example.
- Opportunities outside the equity stack
Some of private capital’s most significant growth may not come on from the equity side at all. Assets in the private credit space, including direct lending, distressed, and mezzanine funding have grown dramatically in recent years – from approximately US$240b a decade ago, to US$837b as of September 2018, according to Preqin. Investors appreciate the diversification benefits of the space as well as the opportunity to access returns (and risk profiles) that are generally higher than their other fixed-income portfolios. And while the industry is certainly subject to the economic and credit cycles, the longer-term trend is toward more activity shifting from traditional lenders to nonbank lenders. Recent years in particular have seen PE-backed credit funds underwrite larger deals that would once have been the exclusive province of the leveraged loan and high yield markets.
- Additional areas of growth
Many opportunities may come from companies that have traditionally been outside of PE’s purview. Longer-term funds, for example, are designed to hold companies for periods of 15 – 20 years or more, opening the investable universe to companies which may not be suitable for shorter hold periods.
The new imperatives
With each passing year, the size and influence of the PE industry have grown tremendously, encompassing a wide range of investment models.
It’s critical for stakeholders to appreciate the degree to which our capital markets are headed toward a new stasis. For much of the last century, the ambition for many entrepreneurs and family businesses was to grow to a size where they could be listed on a public exchange. Increasingly, this is no longer the case, as innovations in private capital provide businesses with a growing array of compelling options. For a wide range of capital markets stakeholders, the implications are significant, as more and more of our economic growth occurs within the realm of private capital.
PE firms will continue to aggressively innovate new structures that can access previously uninvestable segments of the company universe. They’ll continue to expand geographically into regions where PE penetration is much lower. In the developed markets, they’ll continue to build out operational capabilities so that they can justify higher multiples. Sector specialists will use their expertise to uncover hidden opportunities and position themselves as the “best buyer” for an asset. And large managers will increasingly leverage their scale to operate in parts of the markets where competition is dramatically lower.