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Private equity’s transformation: the perpetual evolution

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6 minute read 22 Jan 2025
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Private equity

Private equity firms are seizing market opportunities to drive growth, and new operating strategies will be needed.

In brief
  • PE firms are at an inflection point and are diversifying their holdings to address saturation and market dynamics.
  • Investments in alternative asset classes enable PE to support the emerging ecosystem in high-need areas such as infrastructure, energy and technology.
  • These transformative growth opportunities require different strategic and operational investments across advanced technology, data and reporting.

The transformation of private equity: Why PE should really stand for perpetual evolution.

Embodying the concept of perpetual evolution, the private equity (PE) industry is at another inflection point. As traditional strategies face competitive saturation and as market dynamics shift, PE firms are taking stock of their approach and exploring adjacencies to generate returns.

This transformation is more than a choice: It’s an opportunity to expand and build on the industry’s unique entrepreneurial capabilities to help underwrite economic growth and generate appropriate risk-adjusted returns for investors. This inherent ability to innovate and adapt is deeply embedded in the DNA of PE firms, enabling a constant evolution to create lasting value.

As PE firms embark on expanding into new market opportunities and new ways of thinking, new business models are required to make operations, technology and data management fit for purpose. It’s imperative to simultaneously strengthen the internal infrastructure to support this transformative journey. New stakeholders and new regulations demand a different perspective on everything from operational efficiency to risk management to stakeholder reporting.

As PE firms embark on expanding into new market opportunities and new ways of thinking, new business models are required to make operations, technology and data management fit for purpose.

Filling the financing gap

Private markets play a crucial role in fostering economic growth by providing essential capital to innovative startups, traditional businesses and middle-market companies that often struggle to secure financing through public markets or conventional bank loans. Recently, this support has expanded to areas with substantial funding needs, such as infrastructure, the energy transition and the increasing demand for data and power.

The combination of rising funding demands and a reduction in traditional lending has created a unique opportunity for PE firms to fill the financing gap in the economy. By de-leveraging the banking sector and lowering systemic risk, PE firms can effectively meet the financing needs of industries reliant on capital and leverage.

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Diversification: the new frontier

The strategic expansion into additional asset classes unveils the advantages of diversification, which not only mitigates risk for stakeholders but also opens new market opportunities that may offer more stable and predictable cash flows and returns than traditional private equity investments. By allocating resources and capital to other alternative asset classes, PE firms can provide more stable returns for investors and establish a steady growth trajectory. The private credit and infrastructure sectors represent two such asset classes with significant potential:

  • Private credit: The private credit (PC) market growth rate has more than doubled the equities, fixed income and real estate markets, globally (see Chart 1). However, PC remains only a small part of the overall financial ecosystem, with a 0.6% market share as of year-end 2023. The $140.7t global fixed income market presents a vast opportunity for further market penetration, and closer to home, the US corporate debt market is over $9t alone.

Chart 11

Financial asset size ranked by 10 year growth chart

  • Infrastructure investments: The infrastructure sector is increasingly becoming a key priority for PE firms. Governments worldwide are focusing on infrastructure development providing an asset class that offers stable, long-term returns and aligns well with the extended investment horizons of PE funds. The Global Infrastructure Outlook report reveals the cost of providing infrastructure to support US economic growth is expected to reach $12.0t by 2040, which, based on current investments, translates into a $3.8t funding gap, the largest of any country worldwide.

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Creating long-term capital structures

To meet the growing funding demands of the economy, PE firms are also uniquely equipped to access largely untapped sources of capital. By engaging with firms that control a significant amount of the high-net-worth investor base and fiduciaries that provide retirement solutions, broader pools of capital can be made available to continue to grow these growing asset classes, their need for returns and the ability to diversify investment allocations. Insurance companies are another natural source of capital, given their longer investment horizon. As a result, PE firms are increasingly acknowledging the value of building a diverse and stable investor base, which also comes with its own set of operational considerations:

 

1. Tapping into the high-net-worth market

By targeting affluent individual investors, PE firms can access a vast pool of capital, with about $80t in assets worldwide, that has traditionally been underserved by the industry. This will require greater reporting transparency, as well as educating the investor base and the financial advisors that control that base to gain and retain their trust. 

2. Securing long-term capital

Teaming up with institutions like insurance companies provides PE firms with long-term capital, allowing for more strategic investment decisions. However, this requires substantial investments in operational changes across systems, technology, protocols, data and talent. According to the NAIC,² PE-owned insurers accounted for about 7.1% (up from 6.5%) of the US insurance industry’s $8.5t in assets in 2023, leaving significant room for growth.

To effectively manage relationships with new investors and navigate regulatory landscapes, PE firms must prioritize their operations, including technology modernization.

Operational enhancements required to access these markets

How EY can help

Pursuing transformative growth opportunities comes with a new set of considerations. To effectively manage relationships with new investors and navigate regulatory landscapes, PE firms must prioritize their operations, including technology modernization. This involves significant investments in systems and tools to meet the unique needs of diverse stakeholders. Emphasizing repeatable processes and streamlining operations can lead to significant efficiencies, enabling firms to focus on strategic initiatives rather than routine tasks.

 

Key enhancements should incorporate the following:



The transformation of PE firms into multifaceted financial institutions managing diverse asset classes is not merely a choice but a significant opportunity in an increasingly competitive landscape. The embedded differentiated qualities of PE firms need to be nurtured and supported by an equally differentiated operating model that supports these ambitions.

Keith Caplan, Sanjesh Dubey, Andrew Campbell and Sean Christie also contributed to this article.


Summary 

Private equity firms are innovating to adapt to competitive saturation and shifting market dynamics, evolving the landscape of traditional private equity. By diversifying into new asset classes like private credit and infrastructure and engaging high-net-worth investors and insurers, PE firms are finding new ways to drive growth and diversify returns. Strengthening internal infrastructures and leveraging data and technology are critical for managing new investor relationships and meeting evolving reporting requirements.

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